Financial Autonomy Concept
Financial autonomy indicates the part of the company’s total applications, namely goods and investment applications, financial applications, stocks applications, credit granted to clients, etc., which was supported by capitals owned by the company self, this is, the called equity. This concept is extremely useful on the long term financial risk evaluation since it supplies information about the financial structure and about its capacity to fulfill its long term financial commitments. In fact, the bigger the financial autonomy, bigger will be the part of its applications that are being funded by equity and, consequently, smaller will be the part that is being funded with resource to external funding or debt, that is, smaller will be the degree of the company’s indebtedness.
The bigger or smaller financial autonomy degree of a company is a direct consequence of three main factors:
- company’s profitability levels: the bigger the profits created by the activity, the bigger will be the accumulation of equity and bigger will be its capacity of self-funding contributing directly to raise financial autonomy;
- investments and funding policy: a company with an aggressive investment policy and that resorts to external financial sources to be funded will have a lower financial autonomy tendency;
- type of developed activity: the applications in investment of an industrial company of intensive capital or in a commercial company with big stock quantities of merchandise in the warehouse, are bigger than in a services company, for example, taking to a higher need of external funding and, therefore, to a level of lower financial autonomy.
One of the reasons in order that the companies access to external funding sources is the possibility of financial leverage, this is, the possibility to raise profitability of its equity by resort to debt. Such is possible whenever the profitability of the investments to make be superior to the financial cost of the funding. However, the performance of investments with resource to external funding reduces the financial autonomy level and consequently raises the long term default risk and even bankruptcy. It is up to the deciders to find a commitment situation between the indebtedness financial risk and the profitability increase that this can provide.
Since, as referrer before, financial autonomy indicates a part of the total applications of the company funded by capital detained by the company self, to evaluate the financial autonomy degree is generally used a financial indicator that compares Equity with Assets detained by the company.
FA = E / A
in which FA means Financial Autonomy, E the company’s Equity and A the Assets (or applications) used by the company.