Financial autonomy is the ability of a company or person not to depend on anyone's money to satisfy their purposes. Economic ratios serve us as a great accounting tool analyze economic states that may be "complex" from the start. So at a glance we can see how convenient or favorable what is being calculated is. In this circumstance and post, we are going to clarify everything about the financial autonomy ratio.
After reading the post, you will have a complete notion about what the index of financial autonomy is, how to calculate it and the implications it has for a company. Thanks to this link, the decisions that can be made can be stricter the longer the link. On the contrary, fewer decisions are considered that can be made if the degree of financial autonomy is lower. It also serves as a tool for companies to calculate how well optimized their own resources are against debt. To understand it absolutely, read on to the end.
What is the index of financial autonomy?
The financial autonomy ratio tries to establish the dependence that a company has on its creditorsIn other words, to whom you owe money, the debt. This calculation involves establishing the equity that a company has in connection with its debt. As a result, Linking gives us a link to your ability to borrow. The higher this ratio, the greater the company's ability to survive in the future, fundamentally bearing in mind that uncertain scenarios may arise at times. A good example would be the current environment we are going through, where the pandemic puts these proportions to the test. Companies with a good autonomy ratio are more likely to be less affected than those whose ratio was not very favorable to the problems that may be present.
Some people use the terms "Equity" to say "Equity", it doesn't matter. The important thing is that, whether we use one word or another, we come to refer to the same thing. In this case, to know the equity, it is necessary to subtract the total liabilities (debt) from the total assets.
Formula to calculate the financial autonomy ratio
As we have previously commented, it is a link between equity and debt. The formula is calculated Dividend capital of total liabilities (debt) both short and long term. The resulting number is the coefficient of financial autonomy. To understand it better, we are going to present an example with two companies that we imagine are from the same sector. As an example, companies that are dedicated to the transport of people.
- In the first case, we find a company whose total equity amounts to 1,540,000 euros. Its total debt amounts to 2,000,000 euros. This means that we divide its own funds by its debt, in other words, its liabilities, we get 0.77. This would be the proportion of financial autonomy.
- For the second case, we have a smaller company with an equity of 930,000 euros. Later we have that his total debt amounts to 240,000 euros. After dividing the equity by its debt, we obtain that it has a ratio of financial autonomy of 3.87.
In this circumstance and example, I have tried to put a somewhat "famous" case, that of the second example. On the one hand, we would see how the ratio of the second company is much higher, of 3.87. He is more financially stable, there is no doubt about that. In spite of everything, it could certainly grow much more, but all that potential would only exist latent, it would not be taking advantage of it.
How to interpret the reason?
In general, a company is said to have good financial autonomy when more than half of its resources come from its own funds. But to get an idea, the minimum number of this linkage that a company is expected to have must be 0.8 or more. A link between 0.7 and 1.5 "many times" is the most common value and also the most optimal.
On the one hand, the company would have liquidity and resources to face difficult times. These times may not be very difficult, but lowering your guard and being overconfident usually doesn't bring good results. On the other hand, we would not be talking about a very large debt, which would mean that it has good financial autonomy and in case of need or investments it would not put its survival at risk. Therefore, having or trying to maintain a high ratio is very important, since it represents a sign of strength and stability.
As a piece of information, it must be added that there is no universal financial autonomy ratio applicable to all companies. Each sector is different, and it will depend not only on the field in which you are working, but also on the competition and current business objectives of each moment.
How does the increase in debt affect the relationship?
Taking into account the examples of the two companies described previously, we were able to see how much more the second company could borrow. Let's see it in perspective. If 1 million euros were requested for investments and / or purchase of assets, the value of the company would increase from its 1,170,000 euros (its assets before discounting the debt to know the net worth) to 2,170,000 euros.
The debt would increase to 1,240,000 euros (the € 240,000 plus the extra € 1,000,000). His net worth would remain at € 930,000. This means that its financial autonomy ratio would become € 930,000 divided by € 1,240,000, which would be 0.75. Almost the same, as in the case of the first company.
Apparently this calculation is simple with round numbers, and in fact the commissions and taxes from the liabilities and the acquisition of assets would have to be discounted from the total assets. But when it comes to getting the most out of economic performance, we can see that the second company has now almost doubled in size. In this way, your turnover will be higher and your operating cash flow will increase, allowing you to grow more than before. At the same time, it will continue to have its own resources to face a difficult time, but the autonomy ratio shows that Borrowing more could become dangerous and would not be recommended.
