The Often-Overlooked Financial Metrics That Indicate Company Health...

Here are expert-vetted ways to evaluate a company’s financial performance.

Monitor return on invested capital.

It’s important to look at metrics that provide true insight into a company’s operations and growth prospects , which can’t be gathered from looking at an income statement or balance sheet.

“One undervalued metric I watch closely is return on invested capital (ROIC),” says David Blain, the CEO of BlueSky Wealth Advisors , a financial advisory firm in North Carolina. “ROIC shows how well a company generates cash from the money it invests in its business. Companies able to achieve high returns, say 15 to 20 percent or more, create value and are ready for growth.”

Assess debt-to-equity ratio.

“One often-overlooked financial metric that can be used to evaluate a company’s health is the debt-to-equity ratio,” shares co-founder and president of software company OptinMonster Thomas Griffin. He explains that this ratio indicates a company’s ability to successfully handle its debt obligations.

“A strong debt-to-equity ratio indicates that the company’s current financial standing is stable,” says Griffin. “The company is capable of leveraging growth opportunities, as it can make investment decisions on a need basis.”

Evaluate the cash conversion cycle.

According to Jack Perkins, the founder and CEO of California-based financial services company CFO Hub , a critical financial metric that is often overlooked is the cash conversion cycle (CCC).

“The CCC measures how quickly a company converts its investments in resources such as services and?products?into cash flows from sales,” says Perkins. “A shorter CCC translates to a more efficient company that quickly turns its investments into cash, improving liquidity and reducing the need for external financing.”

Calculate the operating expense ratio.

Different industries prioritize different evaluation metrics. Let’s take real estate, for example, where depreciation matters.

Zain Jaffer, the CEO of Zain Ventures , an assets and investment portfolio management firm in California, shares, “One metric we use in real estate is the operating expense ratio to tell us how well we are controlling expenses relative to income. We take all operating expenses and depreciation and divide this by our operating income to get the OER. We like it because it factors in asset depreciation.”

Track company burn rate.

One commonly overlooked financial metric is burn rate–the rate at which a company spends cash while generating revenue. It’s important to track revenue growth, of course, but it’s also vital to understand how quickly a company is eating through its cash reserves.

Take it from Vipul Jain, the CEO and CFO of PR agency Red Tulip Media : “A high burn rate can indicate excessive spending, which mainly leads to financial difficulties. By closely monitoring the burn rate, I can make informed decisions regarding resource allocation, cost-cutting measures, and fundraising strategies. While the burn rate is not a standalone metric, it provides valuable insights into a company’s overall financial health and helps me make data-driven decisions to ensure long-term sustainability.”

Analyze operating cash flow.

If you want to effectively evaluate a company’s financial standing, operating cash flow paints a clear picture of the revenue generated by its core operations.?

According to Mark Wilkinson, the co-founder and CFO of TileCloud , an online tile store based in Australia, “This metric is one of the best ways you can analyze the operation of the business and see if it can sustain itself and its growth without the reliance on external financing. This makes it a true, tried-and-tested indicator of financial stability in a company.”

Utilize quick and current ratios.

Pivoting to the consumer brand sector, an understanding of quick and current ratios can provide insight into balance sheet health. Often overlooked, these measures indicate the ratio of current assets against current liabilities.

“One direct-to-consumer brand, for example, has great profitability, and its top line is growing nicely in 2024,” says Jeff Lowenstein, a fractional CFO and the co-founder of Free to Grow CFO , an outsourcing service for CFOs. “However, to get to this point, the brand relied on heavy debt usage and extending AP over the preceding years, resulting in poor balance sheet health. We are using the quick ratio and current ratio to help the management team understand the urgency of the situation and how a diligent paydown of debt and AP can be achieved.”

Focus on free cash flow.

Last but not least, free cash flow offers valuable insights into a company’s operational efficiency and financial flexibility.

Meredith Kelley, a VP of finance in Atlanta, explains, “FCF is a key metric that helps to provide a clear picture of a company’s financial health without the potential for earnings manipulation. FCF is the amount of cash that is generated after capital outlays, providing financial flexibility to use that cash for various purposes. When a company can pay dividends, repay debt, invest in the business, or make acquisitions, they are equipped to improve shareholder value, generate financial stability, and drive growth.”

EXPERT OPINION BY YOUNG ENTREPRENEUR COUNCIL

Republished by Greg Herrera: Silicon Valley CEO Group; Helping leaders benefit their companies, families and society...