The coefficient of financial independence (autonomy) is one of the most important parameters that is used to evaluate commercial organizations. It is defined as the ratio of the company's own funds to the balance sheet total.
Introductory information
The financial independence ratio is used to display from which sources (borrowed or own) the main cash flows of the enterprise are formed. It displays how much of the total assets was acquired from the organization’s equity. Because of this property, it has a second name - financial stability ratio. Speaking very simply, this indicator is used to characterize the dependence of the enterprise on its creditors.
How to calculate its value?
In this case, an idle formula is used. The financial independence ratio is calculated as follows:
- Ka = SC / IB.
SC is equity. IB - the result of the balance sheet. As you can see, getting its value is not so difficult as it might seem at first glance. But the details are important here. Indeed, in them, as you know, the truth lies.
What to look for
The financial independence ratio shows a certain value. What is optimal for him? There is no single opinion on this matter. Call numbers in the range from 0.4 to 0.8. Why so? The fact is that the lower the ratio, the less financial stability. Although not everything is as clear as it might seem at first glance. When analyzing the situation, it is necessary to take into account a number of factors, namely:
- The industry average.
- Company access to additional borrowed funds.
- The specifics of current activities.
The impact of financial independence ratio
The lower the value obtained, the less financial stability of the company. This is due to the growth of debt in relation to the amount of owners' equity in the balance sheet. In addition, one should not forget about the possibility of a cash shortage. If the coefficient value drops to zero, this indicates that the company is completely dependent on borrowed capital and the owner does not actually own it. Therefore, it is not necessary to sink so much.
Determining the recommended value is also difficult. For example, for an industrial enterprise with a large production cycle (for example, one year), a value of 0.7 can indicate a significant number of problems. This is due to the slow turnover of funds. Whereas for a chain of supermarkets selling everyday goods (for example, food), a value of 0.3 is acceptable. This is due to the high turnover rate. For example, a loan is taken, salami is acquired, it is sold in a month, a loan is paid and new funds can be attracted.
Specifics of the situation
At first glance, it might seem that it is best if the value of the financial independence ratio tends to unity. But this is a controversial assumption. Yes, in this case, the company has high financial stability. But the efficiency of operations is reduced and the development of the company is limited.
Consider a small example. Suppose there is a construction company that has been contacted by two different enterprises with a request to build additional production workshops. But there is only enough equity to serve only one organization at a time.But the profit from these orders is good - for one invested ruble you can get an additional fifty cents - profitable! What then needs to be done? You can contact a banking institution and get a loan at twenty percent per annum. Fortunately, in twelve months you can fulfill orders. In this case, an additional profit of thirty percent will be received. But if you do not attract a loan, then the construction company will not earn this money. In this case, the financial independence ratio will be 0.5.
But here it is important not to overdo it. It is one thing when funds are raised for orders, there is a material and technical base (or it can be organized without problems), staff. In this case, a loan can do a good job. But it’s a completely different matter if borrowed funds are used for purposes with dubious effectiveness — for example, arranging a vacation for a director, purchasing an official car for him, and the like.
Conclusion
The financial independence ratio is rarely considered separately from the group of indicators to which it belongs. When evaluating an enterprise, to operate exclusively with it means that it works in conditions when substantial distortions of the real state of affairs are possible. Use of this indicator is necessary in conjunction with many other data. Otherwise, there is a rather high risk that an insufficiently adequate base will have to be used for making decisions.