Financial Health

Updated on January 5, 2024
Article byJyotsna Suthar
Edited byprarthana Khot
Reviewed byDheeraj Vaidya, CFA, FRM

Financial Health Definition

Financial health, or financial wellbeing, refers to the financial stability of a person, business, or organization. Its main aim is to inform entities about their financial shape and situation. Companies use various indicators to check their financial health. 

Financial Health

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The four components of financial status that correlate with each other include planning, spending, saving, and borrowing. So, if a person or firm has good financial health, they will be stress-free and lead a good life. However, a bad financial status can bring stress and anxiety to their lives. So, it is a reflection of financial security.

Key Takeaways

  • Financial health is when an individual or a business feels secure about its finances. Factors like income, expenses, socio-economic background, financial literacy, etc., affect financial wellbeing.
  • Higher-income groups in developed countries like the U.S have a poor financial status. However, more than a quarter think debt is vital in determining their financial state. 
  • Analyzing the budget, investments, debt, portfolio, lifestyle, etc., is necessary to improve the financial status. Changing any one metric can improve the financial condition of an individual. 

Financial Health Explained

Financial health is a state that refers to a person’s or a firm’s finances in terms of expenses, savings, and debt. It assesses one’s ability to balance or manage their financial needs and wants and covers dimensions like retirement planning, savings, or expenses on fixed or non-discretionary expenses. It can be either good or bad. However, a bad financial condition can cause stress and debt issues. Therefore, businesses use financial health ratios to determine soundness. The financial health indicator includes solvency, debt, income expense, and liquidity ratios.

It consists of several aspects as it comprises significant aspects of financial life. 

Factors like income, expenses, socio-economic background, savings and investments, credit rating, and inclusive financial planning affect a person’s financial health. In addition, the inflation rate, living costs, job security level, and employment status are significant factors impacting financial health. Besides that, financial tools and capabilities result in positive financial status. But unfortunately, societal status leads individuals to trap themselves in a bad financial status. 

The Financial Health Network conducted a survey that suggested that 17% of Americans suffer financially. 54% find it difficult to manage their finances, and the rest are in good condition. Stress resulting from bad financial health may lead to mental and physical diseases. On the other hand, a good economic condition leads to a better life giving a stress-free time for leisure or other social activities. Hence, The Federal Bureau of Investigation (FBI) states that banks must consider financial safety as a part of financial health. It will, in turn, increase the financial health check. 

Many international studies have shown the interrelation between financial health and higher incomes. For example, according to the ‘Measuring Financial Health’ in the United States, higher-income individuals have poor finances. Yet, at the same time, lower-income groups have good financial management. 

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Financial Health Determinants

  • Net Worth – It is the most basic metric. The overall asset value includes savings, investment, liquid cash, and material things like vehicles and houses. In addition, it includes disposable money for current or future use.
  • Debt – It negatively affects the money at disposal. It is the money that entities owe like debt, loans, credit card payments, and mortgages. Therefore, it is excluded from the net worth.
  • Liquidity And Assets – Economic wealth is not static or consistent. It varies based on various economic entities.
  • Cash FlowCash flow includes a regular and steady flow of income, growing cash balance, and constant gains/returns on investments.
  • Other Factors – Fluctuations in the prices of goods and services impact economic wealth.

Example

Let us look at the financial health example to see the effect globally.

Financial literacy plays a significant role in determining one’s financial position. Unless the person has good knowledge of managing their finances, they cannot be financially good. For example, Rose and Nancy get a monthly income of $2500 for rendering services. The former plans out a budget to divide her income into various areas. These include savings, investments, rent, groceries, bills, etc. 

However, Nancy does not believe in such an idea. Instead, she spends most of her income on parties, clubs, and restaurants. Towards the end of the month, she has a few pennies left. The income level was the same in both cases, but financial literacy mattered. Rose had good financial health, whereas Nancy lacked it. 

Improving Financial Health 

The financial strategy differs according to the individual personal goals of firms and companies. As per Consumer Financial Protection Bureau (CFPB), one-third of U.S. adults (i.e., almost 36%) have trouble managing their finances. Whereas 43% struggle to pay bills and the rest have less than $1000 savings

Steps to improve financial health

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Improving economic condition is a gradual process and does not happen automatically. However, one must put in the required efforts to achieve, balance, and maintain a healthy wealth situation. Firstly, one needs to be aware of financial conditions and make regular economic investment plans to improve economic wellbeing. Let us look at the different rules that will help in improving financial health:

#1 – Analyzing Budget

The first rule for improving financial well-being is to analyze the budget. Then, individuals can divert that money into savings and investments. Some expenses like a child tax credit, medical bills, and other similar bills can attract tax deductions. Individuals and firms often claim such opportunities as it saves a lot of income. Set goals to increase the net worth.

#2 – Planning Budget

Every person or company considers some factors while improving their financial status. It includes planning, spending, saving, and borrowing. However, if spending exceeds, it will increase borrowings. This vicious cycle will continue despite your income level. Thus, proper planning is necessary to improve financial health.

#3 – Reviewing Portfolio

A rich portfolio depicts the future net worth of an individual. However, a restricted portfolio can cut down financial status. Thus, it is important to have a diversified portfolio that includes equity stocks, bonds, and deposits. In addition, it will ensure passive income alongside. 

Also, calculating net worth can declare your financial position among all. Add all the assets and investments and less the expenses (debt) to derive the net worth. 

#4 – Analyze The Debt

Debt is undoubtedly the biggest savior trouble most of the time. But, if it exceeds, it takes no time to turn into the biggest troublesome. For example, the Consumer Financial Health (CFI) Study reflects that 28% of Americans think they have too much debt. In contrast, 26% feel this debt is a stress trigger. 

#5 – Manage The Lifestyle 

There can be some unnecessary components that are eating up the income. Thus, it becomes necessary to analyze these expenses. Although an individual may be earning good, lifestyle matters a lot. For example, a person will earn $2000 per month and spend $1000 on clothes from luxury brands. Therefore, if his income reduces, he might find it difficult to cope with that situation any day.

Frequently Asked Questions (FAQs)

What are financial health ratios?

Certain companies use debt-to-equity (DE) and Price to Equity ratio (PE) to determine their financial status. These ratios help to understand the firm’s liquidity, analyze the market trends, and compare the company’s performance. 

How to check the financial health of a bank?

Investors can look out for banking ratios like Provisioning Coverage Ratio (PCR), Capital Adequacy Ratio (CAR), Net Non-Performing assets (NPA), and the Current Account Savings Account (CASA) Ratio.

Why is financial health important?

Financial wellbeing helps to secure the future by elevating stress. If expenses and savings get properly managed, there will be no chance of debt. It can lead to a successful and happy life. 

How to determine the financial health of a company?

Following are the steps that act as a financial health indicator of a company. 
● Analyzing the Income Statement and Balance Sheet
● Reviewing the Cash Flow Statement
● Calculate the financial ratios 
● Determine the financial status of the company

This article has been a guide to Financial Health and its definition. Here, we discuss the determinants of financial health with example and how to improve it. You can learn more from the following articles –

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