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Founder of Accounting Education

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Are you investor or Are you shareholder and interested to invest your money in any company. Before investing your hard earned money, please learn to measure the financial health of a company. If you will invest in any company share which is not financial healthy, it is sure, it will waste your money also because you want to invest money to see grow in its market price but next day, you will check your demat account and you will be shocked that your invested money value has decreased by 50% because company has financial disease. So, it is good rule to invest in share market on the basis of advice of expert.

As expert, I am advising you, first measure the financial health of a company before investing your money in it.

Following are Simple Steps

1st Step. Calculate the Interest Payment by Company Per Month

It is called monthly debt's interest  obligations. If the company has taken more debt or loan, it has to pay fixed more per month interest on his taken debt or loan. It is necessary because we will use it to find the earning ability of Company in Next Step.

You can find this from company's current income statement.

2nd Step. Calculate Net Earning Ability of Company

It is sure, if the company is earning good money, its market value will increase and your share value will increase in future but if company is not net earning is low or not, its share value will decrease. So, for measuring company's financial health is very necessary.

Just take Company's current Earning Before interest and Tax. This is called EBIT which is famous accounting term also.

Now compare it monthly interest payment. For example if EBIT is Rs. 100 and monthly interest to its debtors are Rs.  70. You can find this also with interest coverage ratio.

Now, it rejects rule of Thumb

Rule of Thumb says

EBIT must be 3 times of its monthly interest payment for saying company financial healthy because shareholder will get reward on his investment

If in above case EBIT is just 0. 4 times of interest payment, it means  reward is being eaten by loan holder and shareholder is just see this play with empty hands of their hard work. So, better is to find this and not to invest their money.

You can find EBIT from company's financial statement or calculate yourself. If not know how to calculate EBIT, read this and learn to calculate EBIT. Learn also to analysis of EBIT at here

3rd Step : To Calculate Monthly Debt Obligation Payment

No debtor  never gives debt to company for 100 years. Debtor gives it for short period which is called short period debt for company and also long period. Both may have monthly installments which company has to pay. What is its value. For finding the financial health of company, it is very necessary to calculate monthly debt obligation payment.

Because if company has not liquid fund, it will use profit of company for repayment of debt. If company did not profit and it is suffering loss, it will start to use the shareholders' fund for repayment of debt. If shareholder's fund is not in cash form,

company management will sell the company's current asset and fixed asset which are bought from shareholders' money for repayment of debt. Due to this, company's total asset value will decrease. After deducting rest liabilities, value of shareholder's capital will also decrease form and due to this, value of share in share market will decrease. Shareholder who bought share at high price will have less market value and they will face loss. So, it is very necessary to check company's monthly debt obligations payment before investment.

4th Step : To Calculate the Current Ratio of Company

Current ratio is the ratio of current assets and current liabilities. It is your short term ability to pay debt with your current asset. It must be 2 : 1. If you have two current asset and one current liability. It is good. But if you have also short term liabilities more than current assets, it will eat your fixed assets. That is not good financial health. We will say it bad financial health as per our measurement.

Current assets also helps to pay emergency expenses. So, more current assets means, more operational ability of business.

5th Step : Check Past 5 Years Performance of Company

It means, last 5 years whether company is gaining profit or loss. If loss, it means, it is the mistake of company.

For example, If I planted a tree of mango  in the nature of God, I will eat unlimited of mangoes on the time. Mangoes are the profit. If I will not give water to plant. If I will not safe it from animals. If I will not take care of giving fertilizers it on the time. Mango plant will die and I will loss my money.

Like this, if company is investing its time, money and energy in any business but it does not gaining the profit, it means, it is the default of management. All money will of shareholder. If any shareholder is ready to sell its shares. He is so smart. But, you must not buy because next day, same company will insolvent and you will get Rs. 0 out of your invested Rs. 1 Lakh.

6th Step : Check Other Important Accounting Ratio

In this, you must check its Debt - Equity ratio, profitability ratio, return on capital employed ratio, cost of capital ratio, working capital turnover ratio and debtor and creditor turnover ratio.  All will help to measure company financial health.

Related Content :

How to Analyze Financial Health in a Company?

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Accounting Education: How to Measure Financial Health of a Company?
How to Measure Financial Health of a Company?
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