Financial Health Check

What is a financial health check?

Financial health check (also called a financial check-up) is a structured, time-limited review of a company's financial position and the quality of its finance function. It examines liquidity, earning power, capital structure (the ratio of equity to debt capital) and working capital (the capital tied up in day-to-day operations), as well as bookkeeping, reporting and planning. The result is an assessment for each area reviewed, with a prioritised list of measures.

It is comparable to a preventive check-up at the family doctor: taking measurements, asking questions, discussing the findings and, where a specialist field is touched, referring the patient to a specialist. The role of the specialists is played here by the tax adviser and the law firm.

The trigger is often the start of an engagement with a fractional CFO, who takes over the finance function for a period, or the preparation of a funding round or a company sale. Other triggers are a change in management or a first warning sign such as a falling liquidity runway. The client is the management or the shareholders. The health check is neither regulated by law nor an audit within the meaning of the German Commercial Code (Handelsgesetzbuch, HGB). It does not end with an audit opinion, but with a professional assessment. Banks and insurers also offer a review of private finances under the same name; for companies, the subject is the financial position and the finance function.

Areas reviewed in a financial health check

• Liquidity and runway: cash balance, monthly cash outflow, how long the funds last in months (runway), available credit lines and the question of whether a short-term liquidity forecast is maintained.
• Profitability and margins: gross margin, EBITDA (earnings before interest, taxes, depreciation and amortisation) and contribution margins, that is, what a product or customer group contributes after deducting the directly attributable costs, in each case over time.
• Capital structure: equity and equity ratio, shareholder loans and subordination agreements (agreements under which a loan ranks behind the other creditors), loan agreements with financial covenants and collateral.
• Working capital: receivables collection period, overdue receivables, trade payables and inventories (working capital).
• Bookkeeping and reporting: how up to date the BWA (the monthly short-form evaluation of the bookkeeping) is, and the monthly accruals, that is, the allocation of costs and income to the correct month. Added to this are reconciled accounts and the reconciliation of the monthly figures to the annual financial statements.
• Planning quality: whether an integrated financial plan exists, how accurately earlier plans turned out and whether the assumptions are documented.

Taxes and contracts are recorded as areas for referral, not assessed. Tax assessments that are still open, an ongoing tax audit, termination rights of customers or banks on a change of shareholders (change-of-control clauses) and guarantees are noted and passed on to the tax adviser or the law firm.

Process in five steps

1. Documents: annual financial statements of the last two to three years and the current BWA with the trial balance (the overview of all accounts with their balances). Added to these are lists of open customer and supplier invoices, the plan, loan and leasing agreements and the shareholder list.
2. Analysis: key figures and time series for each area reviewed, comparison of plan and actual, reconciliation of the BWA and the annual financial statements.
3. Discussions: with management, bookkeeping and the tax adviser to clarify anomalies.
4. Assessment: rating of each area against criteria set in advance.
5. Closing meeting: presentation of the findings and agreement on an action plan with responsibilities and dates.

Result: traffic lights and a list of findings

A traffic-light rating for each area is widespread. Green means no action is needed, amber means improvement within the next few months, red means immediate action. So that the colours do not seem arbitrary, the criteria are set in advance, for example a minimum liquidity runway or a latest date for the BWA.

For each finding, the list of findings states the impact, if possible in euros, the recommended measure, the person responsible and a date. Liquidity topics come first. If there are indications of a ground for insolvency, the situation must be reviewed legally without delay; the health check does not replace this review (early crisis detection).

Significance before a funding round and a sale

A health check anticipates from the inside what investors and buyers will later examine in due diligence, the detailed review before a contract is signed. The difference lies in the timing. Findings such as missing accruals, unexplained differences between monthly reports and the annual financial statements or undocumented key figures can be fixed before the process begins. In an ongoing process, the same findings lead to queries, delays and demands for warranties. Before a sale, the health check also clarifies whether a vendor due diligence is worthwhile.

Practical example: a financial health check before a growth financing

A manufacturer of measurement technology with EUR 9 million in revenue and 55 employees plans a growth financing. The health check produces the following picture:

• Liquidity, amber: By a rough calculation, the funds last around eleven months, and a weekly forecast is missing.
• Profitability, amber: The gross margin is stable, but one of three product lines does not achieve a positive contribution margin after deducting its directly attributable costs.
• Capital structure, green: Equity is positive, and a shareholder loan is subject to a subordination agreement.
• Working capital, red: The receivables collection period has risen from 45 to 75 days within a year. With annual revenue of EUR 9,000,000, one day accounts for around EUR 24,658; the 30 additional days therefore tie up around EUR 740,000.
• Bookkeeping and reporting, amber: The BWA is only available six weeks after month end. Provisions, that is, amounts for foreseeable obligations such as warranty and holiday, are booked only at year end.
• Planning, red: There is only a revenue and cost plan without a balance sheet, and last year's revenue was 20% below plan.
• Areas for referral: Evidence for tax-exempt deliveries to other EU countries goes to the tax adviser, a change-of-control clause in the loan agreement to the law firm.

The action plan begins with receivables management, because that is where the largest liquidity reserve lies, and with a 13-week forecast. An integrated plan is developed in parallel. The company starts the financing process once the plan is in place and the first overdue receivables have been collected.

Distinction: health check, due diligence and auditing

• Vendor due diligence: a review commissioned by the seller and carried out by independent advisers, whose report is made available to the bidders. The health check, by contrast, stays internal.
• Due diligence: the review by an investor or buyer before a transaction. It is more comprehensive, is commissioned by the other side and feeds into the price and the contract.
• Red flag report: a review report condensed to material risks in a transaction process. The health check additionally covers the quality of the ongoing finance function.
• Rating and creditworthiness: the assessment of credit standing by a bank or rating agency, aimed at the ability to repay. The health check is broader and serves the company's own management.
• Auditing: the statutory audit of the financial statements with an audit opinion. A health check passes no judgement on the annual financial statements.

Common mistakes

• Findings without an action plan. A traffic light without responsibilities and dates describes the situation but does not change it.
• Only key figures, no processes. Good figures from unreliable bookkeeping are not a good result. The quality of the data basis belongs in every area reviewed.
• Too late. A health check during an ongoing due diligence leaves no time to fix the findings.
• Traffic light without a yardstick. Without criteria for green, amber and red set in advance, the rating depends on the impression in the conversation.
• Areas for referral treated as done. Recording a tax or contractual topic does not replace its review by the tax adviser or the law firm.

Frequently asked questions

How long does a financial health check take?

Depending on the size of the company and the state of the documents, usually a few weeks. Gathering reconciled data often takes the most time.

Does a health check replace due diligence?

No. Investors and buyers carry out their own review. The health check ensures that the company knows the likely findings before they play a role in the negotiation.

Is a health check an audit within the meaning of the HGB?

No. It is a business review without a statutory framework and does not end with an audit opinion. Statements on whether the annual financial statements have been properly prepared remain reserved for the statutory auditor.

How often should a health check be repeated?

As a rule of thumb, before every major capital event and about once a year in between, to check whether the agreed measures have worked.

Is there a template or an online tool for the financial health check?

For a first impression, yes. A template is usually a checklist with the areas reviewed and fixed criteria for the traffic light. Online calculators, such as those offered by banks, work out individual key figures, for example the equity ratio (equity divided by total assets) or the liquidity runway (liquid funds divided by the monthly cash outflow). Whether the figures are reliable and how well bookkeeping, planning and contracts are set up only becomes clear from reviewing the documents.

The Roemer Capital view

At the start of every CFO engagement, we carry out a financial check. It shows where the finance function stands and sets the order of the work. Before a funding round, we align it with the four pillars that decide whether a company is investor-ready, that is, able to grow disproportionately with external capital. The pillars are runway, KPIs, unit economics (profitability per customer) and governance (rules for management and control).

Clients find the result in Roemer Capital OS, together with benchmarks and the agreed measures. We pass tax and contractual areas for referral on to the company's tax adviser and law firm, because Roemer Capital does not assess these questions.