What is Basic Financing Ratio? Definition of Basic Financing Ratio, Basic Financing Ratio Meaning and Concept
The basic financing ratio is a widely used economic indicator in the field of business management and strategic direction. Its main utility is to provide information to the company on whether it has a greater or lesser margin to borrow in the long term and to what extent.
When planning the operation of the mercantile company and its performance when starting its economic activity, it is necessary to know important variables such as the assets that are available and the capital necessary to be able to act, in order to measure the level of investment and financing required. By definition, the basic financing ratio relates these concepts in search of reaching a desirable financial balance for your economic health.
The financial and equity well-being of a company is achievable according to the business academic vision through a stable balance between the level of investment and the financing it assumes. Being more exact, what relates the coefficient are the so-called permanent capitals with the fixed assets and the necessary or ideal working capital.
The way to carry out its estimation is through a division between financial or capital resources and investments, both variables taken as permanent. Permanent investments are both the set of fixed or immobilized assets and the necessary funds (also called ideal).
Calculation of the basic financing ratio
The resulting coefficient gives an approximate idea of the financial situation of the company, basically showing what relationship exists between the financing it needs given its conditions and the real one it has. Therefore, the formula to calculate the basic financing ratio (CBF) is:
CBF = (Permanent capital / Fixed assets ) + Minimum working capital
The basic financing ratio can also be identified as follows:
CBF = (Permanent capital / Fixed assets ) + Necessary or ideal working capital
Depending on the value obtained we will have different situations:
- Yes it is equal to 1: The company has an ideal working capital, with its fixed assets adequately covered. In other words, it has reached a situation of financial equilibrium in which the necessary circulating capital is equivalent to the real one.
- If it is less than 1: It would be a clear indication that there is a financial imbalance. This will mean that the company is forced to seek short-term solvency in order to meet its debt commitments.
- If it is greater than 1: An excess of permanent capital (fixed assets) would be observed, translatable in turn into excess of long-term resources. In other words, the company is overfunded and perfectly solvent.