Long-term solvency ratio based on fixed capital coverage

Method of calculation

Formula for long term solvency ratio based on fixed capital coverage (golden financial rule): (equity + long-term debt) / fixed assets

Ratio's description

The ratio complements the analysis of long-term solvency ratio based on equity coverage, which should be particularly analysed when the long-term solvency ratio based on equity coverage (golden balance rule) is below 1 or drops significantly in the analysed period. Long-term solvency ratio based on the fixed capital coverage is often called a golden financial rule, which is a less restrictive version of the golden balance rule. Golden financial rule says that fixed assets should be covered by stable financing sources such as fixed capital, being the total of equity and long-term debt.

Ratio's interpretation

  • Ratio's values above 1 indicate that the golden financial rule is satisfied and that the company's financial standing is stable (financial balance is maintained).
  • Ratio's values close to 1 are interpreted as a high risk of financial stability loss.
  • Ratio's values below 1 are interpreted as incorrect, indicating that the golden financial rule is not satisfied and that the financial stability has been lost; in such a case fixed assets are covered by short-term debt, which is very unsafe (the obligation of short term liabilities repayment may lead to the sale of fixed assets, and consequently to the decrease of operating activity due to the decrease of production capabilities).
  • When assessing the changes in ratio's value over time (over few periods):
    • the increase of ratio's value is interpreted as an improvement of financial stability (and balance),

       

    • the decrease of ratio's value is interpreted as a deterioration of financial stability (and balance).