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Financial health

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WHO defines health as "a condition of complete physical, mental, and social well-being and not only the absence of sickness or infirmity" Consequently, financial health can be described as the condition of the financial well-being of a firm or entity. A corporation is considered financially healthy if it maintains adequate liquidity, solvency, productivity, and profitability.

The initial layer of a strong company's foundation is built by liquidity. A business can stay afloat if it can continue to manage its current liabilities promptly. Although liquidity is not the best indicator of a company's financial health, it is the most crucial one to use when screening potential candidates. A corporation that experiences prolonged illiquidity will eventually have to declare bankruptcy.

Solvency draws attention to two aspects of a corporation. First, it reveals whether the business is using an excessive amount of long-term debt to fund its capital demands. Second, it emphasizes the company's financial standing in the event of a worst-case situation (bankruptcy). Even if a corporation declares bankruptcy, it will still be able to repay its creditors and even refund some money to its shareholders.

Thirdly, a company's ability to operate profitably is crucial. One of the most accurate measures of effectiveness is the operating margin. This metric takes into account a company's fundamental operational profit margin following the deduction of the variable costs associated with creating and promoting the company's goods or services. Finally, while a company's liquidity, fundamental solvency, and operational effectiveness are all significant aspects to take into account when evaluating it, the bottom line—its net profitability—remains the same (Koijen,2016).

As an illustration of a financial practice, I shall use Walmart. This morning, I heard with great curiosity that Walmart will begin its "Black Friday" sale early, beginning this Monday, November 21, 2022. Additionally, they have implemented a "Christmas Match" promotion that essentially equals the lowest cost of any competing product or service. Walmart can afford to do this since there will be so many more customers in their stores, and the more customers there are, the more likely it is that those customers will purchase other (non-sale) things. In addition to weakening the competitors, the long-term benefits include establishing brand equity, acquiring new customers, boosting volume, and gaining even more influence with suppliers and manufacturers for the next year.

Reference

Koijen, R. S., Philipson, T. J., & Uhlig, H. (2016). Financial health economics.  Econometrica,  84(1), 195-242.