The equity ratio is an indicator of reliable financial stability

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

The activity of an enterprise can be analyzed based on certain indicators. They are calculated in order to determine how effective the functioning of a business entity is, whether it is advisable to resort to lending to activities and what are its future prospects.

One of the most important areas of analysis is financial stability, which characterizes the ability of an enterprise to independently finance its activities. The level of sustainability is determined by a number of indicators, based on the calculation of which conclusions are drawn about the reliability of a business entity.

The equity ratio is an indicator from the group of those that characterize financial stability. It is defined as the ratio of own working capital and working capital of the enterprise:

Kos=SOK/OS, where SOC is the value of ownworking capital, OS - the amount of working capital.

Equity working capital is an indicator that is the difference between equity and the value of non-current assets:

SOK=SK-NoA, where IC is the amount of equity, NoA - non-current assets.

Sometimes, for a more accurate determination of own working capital, the value of non-current assets is subtracted from the amount of equity, deferred income and a reserve for future expenses. But, as a rule, this is applicable for large enterprises, because in small and medium-sized businesses, the last two indicators are mostly missing when compiling a balance sheet.

Equity ratio indicates its ability to finance activities from working capital without resorting to borrowed funds. The result is considered optimal when the value of the indicator is more than 0.1. Sometimes this indicator is also defined as the working capital ratio. The algorithm for its calculation is identical to the method of the described indicator.

Along with this, there is also a ratio of stocks with own working capital. It is found by dividing own working capital by the amount of reserves (the value is taken from form 1 of the financial statements - balance sheet):

Koz=SOC/Zap, where Zap is the amount of reserves.

This indicator, as well as the coefficient of self-sufficiencymeans, reflects the degree of sustainability of the enterprise and demonstrates how inventories are covered by the sources of financing of the enterprise itself. Its recommended value should exceed 0.5, although the larger the coefficient value, the better for the enterprise. In practice, this rarely happens.

There are cases when the values of the indicated coefficients can be negative. This occurs when non-current assets exceed own funds. Then the indicator of own working capital has a negative value, which, in turn, is reflected in all calculation results. This situation at the enterprise indicates that not only working capital, but also fixed assets are covered by borrowed funds.

Equity ratio is primarily calculated for manufacturing enterprises, because they have large volumes of stocks available and the main source of financing is working capital. Such indicators are mainly of interest to partners and investors, because they make it possible to assess the reliability of the enterprise.