Finance

The fundamental truths of financial sustainability in business

Bilderlings discusses how to keep and increase capital – and make your company stronger.

An enterprise can be considered financially stable if it is protected from external negative influences, regardless of creditors; and the risk of bankruptcy is negligible. Such an enterprise’s income exceeds expenses, the company is free in its financial maneuvers, and funds are used efficiently. If this enterprise is in the manufacturing sector, financial sustainability will be based on the uninterrupted manufacturing process and, of course, successful sales of the product.

We strive only for the highest

In the world of big business, financial stability is calculated using complex graphs and long formulas – from mathematical to logical. It is important to know about the types of financial stability.

The highest type is a company’s ability to grow to a greater extent thanks to its sources of funding. When analyzing the financial situation, say, at the end of a given fiscal quarter or year, and comparing it with today, we can calculate how effectively the company is managing its capital. There are four main types of financial stability.

The first type is the absolute financial stability. In this case a company covers all expenses, for example, related to purchases, from its own assets, without taking loans. The company does not accumulate debts, all systems function without failure, and everything is subject to strict internal financial discipline. The following also applies to this type: the company’s working capital exceeds costs and reserves. In other words, we are talking here about the ideal type of financial stability, which in real life is quite rare.

Much more often you see another type – normal. A company that belongs to this type covers expenses with the help of their operating assets and raised capital. It is believed that the “normal model” is most favorable for the development of the company.

There are two more types, but these already have a “minus” sign. The third type is an unstable financial situation, where an enterprise has problems with solvency. In this case, financial discipline is lax, and the inflow of money to the current account is not regular. The enterprise continually deviates from its own development plan. Finally, the name of the fourth type speaks for itself: the crisis financial situation. In this case the company is financially dependent and can go bankrupt any time. This is because its cash assets and securities are not sufficient to cover its various debts.

The most important indicator

For any entrepreneur who is taking a step into serious business it is important to understand the following: financial stability is a state of the company’s accounts that guarantees its continued stable solvency. A businessman should simply be aware of the extreme limits of changes of sources of funds to be able to cover capital investments, for example, in funds. It is the production reserves that allow the enterprise to work confidently, which leads to a change in its financial situation for the better.

To determine the type of financial stability, it is necessary to calculate its coefficient according to a number of indicators. It is called the coefficient of stability and independence. It should be equal to the ratio of equity and reserves to the amount of assets of the company. The organization’s balance sheet is the basis for its calculation. This ratio reflects the share of the assets of the company that are covered by their own finances – without falling into debt. The remaining share of assets, which is usually smaller, is covered by loans.

Investors and financial institutions issuing loans always look carefully at this ratio. After all, the higher the ratio, the sooner the organization can repay the loan using its own funds. In other words, the higher the coefficient, the more independent the enterprise is.

When calculating the ratio, the following indicators are used: the first is the autonomy (or independence) ratio, then – the financial dependency ratio, and, additionally, coefficients that show the solvency of debtors; liquidity level of assets and many others. In fact, the type of financial stability can be quite accurately determined depending on the level of solvency.

Going up

In very simple terms, these indicators can be calculated, first, by examining the liquidity of the company’s assets – its property, and second, by examining the liquidity of the balance. What is the property of the company –  its assets; – here everything is clear. As for the second, it is calculated using the company’s balance sheet, comparing the assets and liabilities of the company. Indicators of business activity and other components are evaluated as well.

Of course, it is always important to consider other indicators. For example, there is an index that reflects how well an enterprise is provided with its own working – not borrowed – capital. The indicator of the ratio of receivables to assets is also important. It is very important, as it shows how much debtors owe the company and how large a share of this is in total assets. And it is very bad if a large portion of the assets is based on receivables.

Every businessman is concerned with how to increase the financial activity of his enterprise – and its efficiency. In short, an important condition for increasing the efficiency of the company is the rational use of working capital. It is about optimizing the use of money by the company, and also it should be taken into account how successfully the deficit is being liquidated.

A businessman should occasionally be reminded that the basis of everything is strict financial discipline – both internal, in his company, and external, when it comes to deals being made, about the flow of funds into accounts and repayment of debts. The chain that leads to profit must be constantly monitored: costs – output – profits.

And provided that all the rules of the game are respected, the financial stability of the enterprise will only grow, and avoid sliding back to the last type when it comes to bankruptcy.

Related posts
Finance
Where to invest on the internet
Finance
Investing in business: the case for the brave
Finance
Investing for beginners: where to start and how to keep going
Finance
Investing in stocks: first steps
New articles in your inbox
One email per month, only useful content. Help your business grow!