Basic financing coefficient: complete guide with formulas and example

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In the day-to-day management of finance, the so-called basic financing ratio has become a key indicator for measuring whether a company is adequately financing its long- and short-term investments. Although it sounds technical, its logic is quite intuitive: It aligns how long it takes for investments to become liquid with when the sources of financing mature.When these two things don't align, cash flow problems arise, or, conversely, cheaper financing alternatives are missed.

Beyond the academic definition, what is interesting about this indicator is that it allows us to see in a number whether the capital structure accompanies the economic structure. When the coefficient is properly calibrated, the company sleeps soundly; if it deviates, alarms go off.Either there is a lack of resources to meet short-term debt obligations, or there is over-financing long-term debt that should be covered by short-term resources.

What is the basic financing coefficient?

The basic funding ratio (BFR) summarizes the idea of ​​long-term equity equilibrium. Simply put, an entity is balanced if Their permanent investments are financed with resources of the same permanence.while the operational needs of the cycle are met with short-term liabilities.

This idea is formalized in two well-known equilibrium equations in asset analysis: IP = RP + RALP (Permanent investments, IP, are covered by own resources, RP, and long-term external resources, RALP) and INP = RACP (non-permanent or current investments, INP, are financed with short-term external resources, RACP).

If either of the two equalities holds, the other is doubly true; in fact, it is enough for one to be true to speak of equilibrium. Therefore, in its most basic form, the CBF simply expresses the first equality as a quotient. comparing the amount of permanent funding with the amount of permanent investment.

Now, if we define permanent investments as fixed assets (immobilized assets) plus the working capital as shown on the balance sheet, the ratio would tend towards 1 by mere accounting identityTherefore, in practice, two operational variants are used that introduce economic criteria: the existing operational working capital (FREop) and the necessary working capital (FRN), also known as minimum working capital or ideal circulating capital.

How is CBF calculated?

Initially, the CBF is defined as the relationship between permanent financial resources and permanent investments. In standard notation: CBF = (RP + RALP) / IPwhere IP is defined with an operational criterion rather than a purely accounting one.

First variant, widely used in real balance diagnosis: CBF with Existing Operational Revolving Fund (CBF_FREop)Here, permanent investments are set as IP = Fixed Assets (FA) + FREop, so that CBF_FREop = (RP + RALP) / (AF + FREop)This approach captures the need to maintain a certain stable fund that arises from the actually observed exploitation cycle.

Second variant, focused on the ability to achieve ideal balance: CBF with Required Rotating Fund (CBF_FRN)In this case, IP is set to AF + FRN (also called minimum working capital or ideal circulating capital), remaining CBF_FRN = (RP + RALP) / (AF + FRN)It is a normative view: it estimates whether there is enough gunpowder to support the fixed assets and the ideal working capital required by the business.

In literature, following accounting criteria such as IFRSYou will also see the formula expressed with terminological equivalences: Permanent capital = Equity + Long-term debt; Fixed assets = Non-current assets, and Minimum working capital = Required working capitalUnder these equivalences, some sources present the expression in additive form, which should be interpreted as the same relationship as before, unifying names.

In summary, the calculation approach: Choose FREop if you want to measure the current actual balance.Use FRN (or minimum working capital) if you are looking to assess the feasibility of achieving a target balance given the cycle's needs.

CBF Interpretation

The reading of the coefficient depends on the chosen variant, but the underlying logic shares a pattern: 1 is the break-even pointBelow there is a permanent financing deficit and above there is excess long-term or own financing for what are permanent investments.

Acting when using the Existing Revolving Fund (CBF_FREop):

• CBF_FREop = 1The structure is balanced; long-term investments and the operating working capital are covered by permanent resources in adequate amounts and terms.
• CBF_FREop < 1There is an imbalance due to a shortage of permanent resources. Part of the fixed assets or the operating fixed assets. It is being financed in the short term, increasing the risk of liquidity stress because maturities occur before the asset is converted into cash.
• CBF_FREop > 1There is also an imbalance, but of the opposite sign. There is excess permanent financing for the volume of long-term investments, indicating that There is working capital financed with own resources or long-term financing.The company gains solvency margin, yes, but it is probably forgoing lower-cost short-term financing.

Interpretation when using the Required Working Capital (CBF_FRN):

• CBF_FRN = 1There are sufficient permanent resources to cover fixed assets and ideal working capital; The company is in a position to maintain the objective equilibrium.
• CBF_FRN < 1: there is not enough permanent financial mass to aspire to the desired equity balance; There is a lack of own and/or long-term resources to cover AF + FRN.
• CBF_FRN > 1Permanent capital exceeds what is needed for AF + FRN, There is ample room to achieve and maintain economic and financial equilibrium..

A practical note: Having a ratio greater than 1 does not automatically make it "better".While it provides a buffer, it can also reveal an inefficient capital structure due to an excess of permanent resources financing working capital.

Practical example: the EQUIFINSA case

Let's see how it works with real data from two periods of a fictitious company, EQUIFINSA. The amounts are in monetary units. and allow calculating both approaches of the CBF.

With this data, the permanent investments are first constructed (according to the variant) and the permanent capitals are added together. From there, the quotient comes out on its own..

Interpretation of period 1: CBF_FREop > 1 (1,10) and CBF_FRN also above 1 (1,08). This reveals a “conservative” imbalance: 2.120 um of permanent resources left over Regarding AF + FREop (23.120 – 21.000). The company is financing part of its working capital with RP or long-term debt, which demonstrates prudence in liquidity but a possible unnecessary cost by forgoing cheaper short-term alternatives.

Interpretation of period 2: CBF_FREop < 1 (0,93), while CBF_FRN = 1,00. Here the table changes: 2.000 units of permanent capital are missing to cover AF + FREop (27.000 – 25.000). Part of the permanent investments are being supported by current liabilities, increasing the risk of short-term cash flow problems. However, from the perspective of the FRN, the company would have just enough resources to sustain its fixed assets and ideal working capital, therefore There are real possibilities of restoring the balance.

This example shows why it's a good idea to look at both lenses. FREop tells you how you are today with your actual transaction, while The FRN tells you about the feasibility of reaching a target state if you adjust the circulating currency to what is necessary.

Relationship with debt risk

Related to this analysis is the ongoing debate about how much debt to take on. excess of debt relative to equity It strains viability: if the cash flows for the period are insufficient to meet maturities, situations of payment suspension and even bankruptcy may arise if even selling assets does not cover the obligations.

At the opposite extreme, a excess of own resources This could be a symptom of underinvestment. In competitive markets, failing to invest at a sufficient pace means falling behind in productivity and innovation. If the debt burden is too low, perhaps The company is too conservative and leaves opportunities on the tableThe CBF helps to see if that conservatism is financing working capital with permanent capital.

Other ratios that should be looked at at the same time

The CBF doesn't exist in isolation. For a complete picture of balance and profitability, The financial management cross-references this metric with other equity, economic, and efficiency ratios.

• Short-term solvency (liquidity)Current Assets / Current Liabilities. A value greater than 1 suggests the ability to meet immediate obligations.
• Basic financing coefficient (in equity notation): (Long-Term Debt + Equity) / (Non-Current Assets + Minimum Working Capital). It's the same logic as before, with a different label.
• Long-term solvency (guarantee)Total Assets / Total Debt. A ratio between 1,5 and 2,5 is generally considered reasonable; below that, dependence on creditors is high.
• Total debtDebt / Equity. If it is much greater than 1, solvency deteriorates due to a lack of their own resources.
• WarrantyTotal Assets / Fixed Assets. Measures how many times total assets cover fixed assets.

In addition to property-related matters, Profitability and efficiency ratios provide the economic "why". of the financial structure that is chosen.

• ROI or ROA (Return on investment/assets): Before taxes, EBIT / Total Assets; After taxes, (Net Income + Financial Expenses·(1–t)) / Total Assets. It is advisable to use tights in the denominators.
• ROE (Return on equity): Profit after tax / Equity (on average). Relate profitability and leverage.
• Cost of debti = Financial Expenses·(1–t) / External Funds with cost. Useful for comparing with ROI and deciding whether leverage adds or subtracts.
• Deadpoint or break-even point: in sales, CF·Sales / (Sales – Variable Costs); in units, CF / (Price – Unit Variable Cost). Defines the minimum volume to avoid loss.
• Average maturation period (AMP): time from when 1 um is invested in the production process until its recovery in cash.
• Customer Capital Investment (PMC)Customer balance / Sales. The higher, more capital tied up in accounts receivable.
• Supplier financing (PMP)Accounts Payable / Purchases Balance. Describe How much does the provider finance your cycle?.
• BAII/Sales y variable cost safety ratio (Operating Profit / Variable Costs): indicators of margin and resilience to changes in volume.

Best practices for using CBF judiciously

When making decisions, it is advisable not to take the number as the absolute. The CBF is a beacon, not an autopilot.Use it in conjunction with the collections and payments calendar, sales forecasts, and your industry reality.

If CBF_FREop falls below 1, one way is strengthen permanent resources (capital increase, long-term debt) or adjust the cycle to increase operating FRE (improve collections, inventory turnover) and fit deadlines.

If CBF_FREop exceeds 1 by a wide and structural margin, check if You have working capital financed "long term" without needingYou could optimize costs by migrating part of it to short-term policies or lines of credit, always with prudence to avoid straining cash flow.

With the FRN approach, if the CBF_FRN indicates a deficit, perhaps your ideal circulating currency is incorrectly estimated or requires additional permanent investment. If you nail a 1, remember that's a fair balance; Having a small margin above can be healthy. to absorb operational fluctuations.

And finally, Beware of jumping to conclusionsA "perfect" CBF does not compensate for a poor ROI or a portfolio of clients who pay late; the complete diagnosis requires the battery of ratios discussed.

Viewed in perspective, the basic financing coefficient lets you know if The company is walking with the right shoes For the route you're taking: neither heavy boots for a sprint, nor thin shoes for a trek. If you align investment and financing timelines, monitor the working capital (existing and necessary), and cross-reference the analysis with liquidity, solvency, and profitability, It greatly reduces the likelihood of scares and you move closer to an agile, stable, and efficient structure.

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