Core Health is the foundation of our risk model. We measure Core Health through an industry specific analysis of 62 financial ratios. Core Health is then dynamically combined with Resilience to identify default probability, which is further explored in FHR Model 101. This article will focus on that first step: measuring Core Health.
What is Core Health?
Core Health measures how efficiently a company is structured and operated. Specifically, Core Health indicates a company's level of sustainability, and considers a company's performance at generating returns given the capital structure and cost structure employed. Companies with strong Core Health are better placed to take advantage of opportunities in the market, and withstand shocks. Many of the Core Health ratios provide insight into efficiency by combining line items from multiple financial statements.
Core Health is a measure of operating and structural efficiency based on the industry-specific analysis of 62 financial ratios.
The Financial Health System expresses Core Health as a 0-100 score, called a Core Health Score (CHS). Like the FHR, the CHS includes 5 color coded categories.
We also provide four Performance Scores, which are component scores for the CHS and help you understand the company's strengths and weaknesses. These include:
- Operating Profitability,
- Net Profitability,
- Cost Structure Efficiency, and
- Capital Structure Efficiency.
The Importance of Core Health
Understanding Core Health provides a critical advantage when evaluating default risk. Research shows that a company with Strong or Very Strong Core Health has a low probability of default, regardless of items like leverage and liquidity. When a company's Core Health becomes Medium or Poor, then leverage and liquidity become increasingly important. In the Financial Health System, Core Health provides the context required to properly understand Resilience and its role in the risk framework. Our Quadrant Analysis helps you understand the contribution of Core Health to the overall FHR.
You can read more about how we calculate Core Health in FHR Model 101 and Advanced Methodology.