Defining Financial Condition and its Warning Signs

Author: Chris Peterson, Michigan State University,

Because members are owners, they need to care about the financial condition of their cooperative. Financial condition reflects a firm’s ability to raise and use funds. Strong financial condition results from effective operating profitability (revenues exceed expenses), efficient asset management (only necessary and profitable assets are invested in), efficient capital structure management (liabilities are not used in excess) and appropriate pay out of returns to owners through dividends and appreciation of ownership value.

Financial condition is weak if certain situations arise or have a strong probability of arising. First, if a firm cannot pay its bills, then financial condition is weak. If its short-terms bills cannot be paid, the firm is said to have a liquidity problem. If its long-term bills cannot be paid, it is said to have a solvency problem.

Second, a firm has weak financial condition if it cannot make the best investments in its assets. For example, a sign of weak financial condition would be the inability of a firm to raise new funds when it has an opportunity to invest in a new profitable asset (like a new production facility or a new product). This situation would likely arise when the firm (1) has too much debt already, meaning that bankers would not want to give the firm access to new lending, or (2) has not performed well in paying returns to owners and thus they will not put new equity capital.

Third, a firm has weak financial condition if it cannot pay its owners appropriate returns for their investment. Even if a firm can pay all its bills and for all its liabilities, it still has weak financial condition if it has nothing remaining for payment to owners. Owners are not getting what they need to reward their investment.

A cooperative is no different from other firms in needing strong financial condition (ability to pay bills, make good investments and pay returns to owners). As owners, members have a fiduciary responsibility to be sure their cooperatives have strong financial condition. This responsibility is directly overseen by the cooperative’s board of directors.