What Does a Financially Healthy Business Actually Look Like?
A busy business is not necessarily a healthy business.
High turnover does not guarantee strong profits. A large bank balance does not necessarily mean the company has plenty of money available. And rapid growth can sometimes make a business financially weaker rather than stronger.
So what does a financially healthy business actually look like?
There is no single number that provides the answer.
Instead, financial health comes from a combination of profitability, cashflow, manageable costs, reliable customers, sensible reserves and good visibility over what is happening inside the business.
Understanding these areas can help business owners identify weaknesses before they become serious problems.
Profit should be sustainable
A healthy business should make enough profit to reward the owners, fund future investment and provide some protection against unexpected events.
But simply reporting a profit is not enough.
Look at whether profit is:
- Consistent
- Increasing over time
- Supported by healthy margins
- Generated from the core business
- Sufficient to fund future plans
A company that makes £100,000 profit one year and £5,000 the next may require more investigation than a company consistently generating £50,000.
The quality and predictability of profit matter.
Regular accountancy and financial reporting can help business owners understand how performance is changing throughout the year rather than waiting for statutory accounts.
Cash should not constantly feel tight
Profitable businesses can still experience cashflow problems.
Money may be tied up in:
- Unpaid customer invoices
- Stock
- Equipment
- VAT
- Corporation Tax
- Loan repayments
- Growth expenditure
However, a healthy business should not spend every month wondering whether there will be enough money for payroll, suppliers or HMRC.
The company should understand:
- What cash is currently available
- What payments are coming up
- What customers are expected to pay
- How much tax needs to be reserved
- What minimum cash balance should be maintained
The objective is not to hold excessive amounts of money unnecessarily.
It is to have enough liquidity to operate without constantly reacting to short-term pressure.
Customers should pay within reasonable terms
A business can report excellent sales while struggling financially because customers have not actually paid.
Review your aged debtors regularly.
Look for:
- Increasing overdue balances
- Customers consistently exceeding terms
- Large disputed invoices
- High dependence on one debtor
- Old debts that may never be recovered
If customers owe £200,000 but the company has only £10,000 available in the bank, the business may be profitable on paper while experiencing considerable pressure.
Good bookkeeping helps keep customer balances current and makes overdue invoices easier to identify.
No single customer should create excessive risk
Winning a large client can transform a company.
It can also create significant risk.
Imagine one customer generates 60% of annual revenue.
If that customer leaves, reduces spending or becomes insolvent, the effect could be immediate.
A healthier business normally has a sufficiently diversified customer base that losing one account would be painful but manageable.
Ask:
- What percentage of revenue comes from our largest customer?
- What percentage comes from the top five?
- Could we replace that revenue?
- How long would replacement take?
- Would our cost base adjust quickly enough?
Customer concentration is an important financial risk that turnover figures alone do not reveal.
Margins should be understood
Businesses should know how much money remains after delivering their products or services.
Suppose you sell a service for £5,000.
If delivering it costs £4,500, the £5,000 sale is far less valuable than it first appears.
Healthy businesses understand:
- Gross profit
- Gross margin
- Net profit
- Net margin
- Profitability by service
- Profitability by customer
Margins should also be monitored over time.
If your gross margin falls from 45% to 35%, understand why.
Possible explanations include:
- Supplier increases
- Wage inflation
- Discounts
- Poor pricing
- Additional work being provided free
- Changes in the type of customers being served
Small margin changes can have a substantial effect on annual profit.
Costs should grow more slowly than value
Business costs naturally increase as a company grows.
More sales may require:
- More employees
- Better software
- Larger premises
- Additional vehicles
- More equipment
- Greater marketing expenditure
That is not necessarily a problem.
The important question is whether the additional expenditure creates sufficient additional value.
For example, spending another £50,000 on employees may make sense if those employees allow the company to generate £150,000 of additional gross profit.
Costs become problematic when they continue increasing without a corresponding improvement in revenue, productivity or profitability.
Tax should not continually be a surprise
Corporation Tax, VAT, PAYE and other liabilities should be planned for.
If every tax deadline creates a cashflow crisis, the business may need better financial forecasting.
Consider keeping tax reserves separately so that money collected or accrued for HMRC is not confused with available operating cash.
Regular reporting can also help estimate future liabilities before the payment deadline arrives.
Merranti’s approach is based around providing business owners with current accounting information so they can plan before year-end rather than only reviewing figures afterwards. (Merranti Accounting)
The business should have some financial breathing room
Unexpected events happen.
A major customer may leave.
Equipment may fail.
Sales may temporarily decline.
A supplier may increase prices.
A healthy business should ideally have enough financial resilience to deal with a setback without immediately depending on emergency borrowing.
The appropriate cash reserve depends on:
- Monthly overheads
- Revenue stability
- Customer concentration
- Industry
- Borrowing
- Seasonality
- Growth plans
There is no universal amount.
But a company operating permanently with almost no available cash has very little room for error.
Debt should be manageable
Borrowing is not automatically a sign of financial weakness.
Debt can be useful when it funds:
- Equipment
- Expansion
- Acquisitions
- Working capital
- Property
- Productive investment
The problem arises when borrowing is repeatedly required simply to cover normal operating costs.
Monitor:
- Monthly repayments
- Interest rates
- Loan-to-asset relationships
- Overdraft usage
- Credit-card balances
- Ability to service debt if sales fall
A healthy business should understand why it is borrowing and how that borrowing will ultimately generate or protect value.
Growth should generate more than turnover
Growing turnover feels positive.
But sustainable growth should improve the underlying business.
Ask whether growth is producing:
- More profit
- Better margins
- Greater cash generation
- Stronger customer diversification
- Improved systems
- More management capacity
If turnover doubles but cashflow deteriorates and profit remains unchanged, the business has become larger without necessarily becoming stronger.
Jason Fudge, Merranti’s Managing Director, works with business owners on commercial and financial decisions around sustainable growth, including profitability, capacity and cashflow. (Merranti Accounting)
The owner should know where the business is heading
Financial health is not only about today’s numbers.
A business should also understand what is likely to happen next.
Useful forward-looking information might include:
- Sales forecast
- Cashflow forecast
- Budget
- Recruitment plans
- Planned investments
- Tax estimates
- Debt repayments
- Break-even point
Forecasts will never be perfectly accurate.
Their value comes from forcing the business to consider what might happen and what action would be needed if reality differs from expectations.
Financial records should be current
A business cannot manage what it cannot see.
If bookkeeping is four months behind, the owner may be making decisions using financial information that no longer reflects reality.
Good financial systems should allow the business to understand reasonably quickly:
- Sales
- Expenses
- Profit
- Cash
- Debtors
- Creditors
- Tax liabilities
Merranti emphasises proactive accounting and access to current financial information rather than relying solely on accounts prepared months after year-end. (Merranti Accounting)
What does an unhealthy business often look like?
A business may require closer attention where several of these issues appear together:
- Turnover rising while profit falls
- Continual cash shortages
- Increasing overdue invoices
- Repeated borrowing for normal expenses
- Large unexpected tax bills
- Declining margins
- Heavy dependence on one customer
- Bookkeeping several months behind
- No cashflow forecast
- Directors withdrawing money without reviewing company requirements
One issue alone does not necessarily mean the business is in trouble.
Patterns are what matter.
A simple monthly health check
Once a month, ask:
Profitability: Are we making enough profit?
Cash: Do we have sufficient money for the next few months?
Customers: Are we getting paid?
Margins: Is each sale still producing enough return?
Costs: Are expenses increasing faster than revenue?
Tax: Have we reserved enough?
Debt: Are repayments manageable?
Growth: Is expansion improving the business financially?
Forecast: What does the next three to six months look like?
Those questions can reveal far more than simply checking the bank balance.
Frequently Asked Questions
What makes a business financially healthy?
A financially healthy business typically combines sustainable profitability, adequate cash, manageable debt, strong margins, reliable customer payments and good visibility over future commitments.
Does having lots of money in the bank mean a business is healthy?
Not necessarily. Some of that money may already be required for tax, suppliers, payroll or customer deposits.
Can a profitable business still be financially unhealthy?
Yes. Poor cashflow, excessive debt or high customer concentration can create significant risk even when accounts show a profit.
How often should business finances be reviewed?
Monthly reviews are appropriate for many businesses, while cash and customer debts may need to be monitored more frequently.
Can an accountant help assess business financial health?
Yes. Management accounts, cashflow forecasting and regular financial reviews can help identify strengths and weaknesses that are not obvious from annual accounts alone.
Final thoughts
A financially healthy business is not simply one with high turnover.
It should have:
- Sustainable profit
- Reliable cashflow
- Healthy margins
- Manageable costs
- Customers that pay
- Appropriate reserves
- Controlled borrowing
- Reliable financial information
- A realistic view of the future
The strongest businesses understand these areas before making major decisions.
At Merranti Accounting, we help business owners understand what is happening behind the headline numbers so they can make better decisions around profitability, cashflow and growth.
Explore our accountancy services or contact Merranti Accounting to discuss the financial position of your business.
Written by Jason Fudge
Managing Director, Merranti Accounting
Jason works closely with business owners on commercial strategy, financial management and sustainable business growth. His focus is on helping owners understand what is happening inside their business and use that information to make stronger commercial decisions. Merranti identifies Jason as its Managing Director and co-founder. (Merranti Accounting)
Author image: Use Jason’s existing Merranti headshot.
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