One common mistake in evaluating a company is overemphasizing revenue. While revenue indicates the size of a company’s business, it does not necessarily reflect the company’s financial stability and reliability.

High revenues can sometimes obscure underlying financial issues, such as thin profit margins, unsustainable costs, increasing debt, or challenges in paying suppliers. A company may generate substantial revenue, but if its expenses exceed its earnings, it could still face risks.

After learning how to read a financial statement effectively, let’s explore the top three metrics that genuinely indicate a company’s financial health—ensuring you’re not misled by isolated numbers.

Net profit and Equity: the Foundation

Before diving deeper, let’s do a quick recap. We’ve previously discussed net profit and equity, as these two indicators summarize a company’s financial position and its economic performance over the last fiscal year.

• Equity: This shows whether a company’s total assets exceed its liabilities. A negative equity balance is a major red flag, indicating that the company is technically insolvent. In such cases, shareholders must decide whether to liquidate or recapitalize the business.
• Net Profit (or Loss): This figure reveals whether the company made a profit or incurred a loss in the last fiscal year. A company operating at a loss is spending more than it earns—a situation thatcan threaten its financial stability.

However, positive net profit and equity alone don’t necessarily indicate that a company is healthy. To gain a clearer understanding, we must delve deeper.

1) Is the business profitable?

To understand whether a business is profitable, let's first look at the sales revenues in the income statement to check whether they increased over time. A single financial statement isn’t enough—you should assess performance across multiple consecutive years.

Sales revenues should  be compared to the production costs. Just look at EBIT (Earnings Before Interest and Taxes), which reveals whether the company’s core business is generating profit or operating at a loss. A negative value indicates the company's core business is losing money, even if the overall net profit is positive. This is because net profit also includes financial income and expenses, which can affect the final result.

The ROI Ratio

To assess whether the generated profit is substantial relative to the company’s investments, EBIT should be compared to Total Assets—the capital invested in acquiring assets like machinery, real estate, licenses, or raw materials.

The ratio between EBIT and Total Assets is called Return on Investment (ROI), an indicator of how efficiently a company generates profit from its invested capital. The higher the ROI, the more profitable the business.

ROI = EBIT / Total Assets

2) How Much Debt Does the Company Have?

To answer this question, let's comparing two key figures from the balance sheet: 

• Total Liabilities -  which represents the company's financing from external sources:
• Equity - internal financing sources, such as shareholder capital and retained earnings)

Which of these two does the company rely on more?

The Leverage Ratio

Dividing total liabilities by equity gives us the Leverage Ratio, which measures how much a company depends on external financing compared to its own capital.

Leverage = Total Liabilities / Equity

How do we interpret the ratio?

• > 1: The company finances itself more with debt than with its own capital.
• > 2: A warning sign—the company’s debt is twice its equity, indicating high financial risk.

Short- vs. Long-Term Debt

High debt isn’t always a problem—it depends on its structure. There’s a big difference between having a recently obtained long-term loan versus facing imminent payments due to short-term liabilities.

To assess this, check whether liabilities are primarily composed of long-term debt (Non-current Liabilities) or short-term debt (Current Liabilities), such as accounts payable to supplie

3) Can the Company Pay Its Suppliers?

To settle short-term debts, a company must have sufficient liquidity or assets that can be quickly converted into cash.

To check this, look at Current Assets—these include cash on hand, accounts receivable, inventory, and any short-term investments.

The ratio between Current Assets and Current Liabilities is known as the Current Ratio.

Current Ratio = Current Assets / Current Liabilities

Generally, a value of at least 1.5 indicates that the company has adequate coverage for its short-term debts.

Conclusion: Revenue Isn't Everything

A company’s financial health isn’t determined by revenue alone. Isolated figures can be misleading, which is why profitability, debt, and liquidity analysis are crucial.

By using these key financial indicators, you can assess whether a company is well-managed, generates sustainable profits, and can meet its financial obligations.

Next time you review an Extended12M report on s-peek, start by examining the financial statements and analyzing the last three years’ reports to get a solid understanding of the company’s real financial health.