Financial independence is Definition, examples and formulas

2024 Author: Henry Conors | [email protected]. Last modified: 2024-02-12 02:55

Financial independence is quite a serious topic. What milestone can be considered its achievement? How to achieve it? Is the collected material in the form of a plan? Is it hard to get financial independence? How far will you have to go to be a free person? All this will be considered within the framework of this article.

General information

Start with a definition. Financial independence is the highest degree of well-being, during which a person no longer has to focus on the amount of money available to satisfy his own needs and requests. It is also often used as a synonym for the word "freedom". What is causing this situation? Financial independence is ensured in cases where a person receives income from two or more sources. Additionally, within the framework of the article, the enterprise will also be considered, but about it a little later. Let's go back to our man. In the described situation, income should exceed expenses and ensure the growth of tangible and monetary assets. The optimal situation is when the sources of funds can operate in a passive mode - that is, without human intervention (or with a minimum).

To achieve financial independence, most people have to go through a difficult path. It depends on what state the person has at the moment. The lower it is, the more difficult the path will be. Most often, it takes years (or maybe even decades). You won't be able to get through it quickly. Only having the desire, perseverance, constantly overcoming difficulties and gradually strengthening one's position, one can achieve financial independence in the end result and relax relatively calmly. Why such a strange wording? Why is the word "relatively" mentioned? The fact is that the presence of financial freedom does not mean a complete retirement and the possibility of uncontrolled squandering of money. No. You will need to control and manage your assets. However, those who achieve financial independence are very good at managing their funds.

The Path to Freedom: First Steps

If a person is in a debt hole, then it is unlikely to make a quick transition to independence. Let's take a look at the phases you'll have to go through:

1. The first stage. Let's say that the current location is a financial hole. The first thing we need to strive for is to move to a state of instability. To do this, you need to pay off your debts. This is achieved by working in two directions: hardsavings and increasing active income. In the first case, everything will have to be reviewed. Alcohol? We become teetotalers and do not use at all. Cigarettes? Likewise. Entertainment? Well, let's go for a simple walk. We keep track of expenses and income. All proceeds are used to pay off debts. At the same time, we are working on increasing active income. This can be achieved by changing jobs to a higher paying position, looking for an additional part-time job, a second job, and so on. And that's it, no other options. You should not invest the last money in various dubious and risky projects that promise super profits. So, most likely, the pit will only get worse.
2. Second stage. So, we managed to reach a state of financial instability. At this stage, there are no debts, and incomes are approximately equal to expenses, but at the same time slightly exceed them. You shouldn't relax. It is enough to stumble and take one wrong step, and the pit will immediately return. Now our goal is financial stability. At this stage, it is necessary to continue to increase active income, create reserves and savings, and also learn how to competently and effectively plan the budget. At this stage, the first passive income appears, a good example of which is interest on bank deposits. But, the greatest attention should be paid to the development of sources of replenishment of the personal budget. Reserves act as a safety cushion that supports us in force majeure circumstances. Savings are used to strengthen the base of tangible assets. Competent planningallows you to increase the speed of achieving the goal.

The Path to Freedom: The Last Stage

So, the final phase of the transition to financial freedom. Here stability replaces independence. Very often this is a transition from active to passive income. In this case, attention is paid to:

1. Building capital. In fact, this is the preparation of highly mobile funds.
2. Creation of passive income sources. We can say that a person becomes an investor. I would like to draw the attention of readers to one very important point: sources. In plural. The more there are, the better. Why? The fact is that investing in one project, especially in our unstable economic and political situation, is a very risky action. Therefore, sources must be diversified to the maximum.
3. Gradual shift of emphasis from active to passive income. Gradually, as passive sources of income grow, they will take an increasing share of income. But, at the same time, it should be borne in mind that if a certain work brings pleasure, then you can safely continue to do it.

This is what the path to financial independence looks like. There are necessary tangible assets, funds and opportunities. All that remains to be done is to ensure the competent management of capital and personal finances through the constant accumulation of monetary and tangible assets, as well as passive income. If you start not from a hole, but a level higher, then the path will beshorter. In addition, the characteristics of individuals can bring specifics to the process of its implementation. For example, since the abolition of the Bretton Woods system, the real value of gold has doubled. Therefore, if someone wants to have a weakly liquid, but reliable asset, he can buy himself a few bars or gold jewelry for his soulmate (if he is sure that she will not leave him). If you study all this in more detail and analyze all the possible and available options, you can easily make sure that there are ample opportunities to achieve your own financial freedom.

Is there a good book on this topic?

Yes, we can recommend Bodo Schaefer's "The Path to Financial Independence". Why a book, if all the general ideas can be placed in an article? And then the question arises of how much time is devoted to the thought process aimed at achieving financial independence. It just seems like the game is not worth the candle. For example, how long does a person usually think about improving well-being? At best, a couple of minutes a day, or maybe once a month. What if you think about it for a few hours? And take the time to do this, without looking up from the book "The Path to Financial Independence." Bodo Schaefer, moreover, is quite an experienced person in this regard, who considers a large number of hidden mechanisms of our psychology. Some readers will constantly say to themselves: this is obvious and understandable. But, even in this case, you should continue to read the book. Why? Right, because during this process, a person thinks aboutown position and how good it is to be free. The Path to Financial Independence by Bodo Schaefer allows you to focus on this thought for a couple of hours. Of course, this is far from the only book of its kind. Besides her, there are many others. But you have to start somewhere, right? And it is desirable that the first experience was positive. After all, it can be said about many books that when you read them, you understand that all useful thoughts can be put into a few sentences. While Schaefer's financial independence in this regard is a very good option.

What about the enterprise?

Commercial structures and their future depend quite heavily on current sustainability. And it has a direct impact on the financial independence of the enterprise. What it is? This is a designation of the state of affairs of a commercial structure, which displays the share of borrowed funds in the capital of the company. Coefficients help to study the situation. Thanks to their dynamic analysis, you can understand what the situation is, as well as make a forecast regarding the future. The value of the coefficients of financial independence is a reflection of the situation in the enterprise. Let's look at them in more detail. So:

1. Coefficient of financial independence and autonomy. It is used to characterize the share of the company's equity capital in the available cash resources. Determines how independent the firm is of borrowed funds. The optimal value is greater than 0, 5.
2. Financial risk. Meaning for himmust be less than one. If the amount of borrowed funds is greater than own funds, then this indicates that the enterprise is not stable enough.
3. Capitalization. The peculiarity of this coefficient is that in an optimal situation its constant growth should be observed. Reflects the level of capital generated in business processes.
4. Immobilization of long-term debt. Used to detail the system of financial resources, during which the emphasis is on the long-term aspect of formation.
5. Mobile equity. Shows what part of it is used to finance current activities. Must be greater than 0, 3.
6. Interest coverage. Used to reflect the relative yield of loans. Shows how many units of profit the company receives per unit of borrowed funds.
7. Dividend load. Describes the policy of cash payments to investors and owners. Displays the actual amount of dividends per one ruble of invested funds.

The most generalizing factor here is the coefficient of financial independence and autonomy.

Some nuances

Before you rush to calculate the value of indicators, you need to understand a few important points. First, there are no uniform unified strict standards for the listed coefficients. A lot depends on the conditions in which you have to act:

1. Accounting policy.
2. Turnoverfunds.
3. Industry affiliation of the enterprise.
4. Money turnover.

Let's look at a small comparative example. As a working material, we take the coefficient of financial risk. For manufacturing enterprises, it is recommended that it does not exceed 0.15. For mixed enterprises, the already mentioned 0.5. But for trading companies, it can be several units. Especially they like to use various large objects located on thousands of square kilometers of area, for example, supermarkets. Therefore, acceptable indicators are established only using spatio-temporal comparisons. At the same time, if the financial independence ratio is calculated from the balance sheet, then one should take into account the modest fact that the data can be partially distorted or manipulated. Therefore, it is necessary to carefully monitor all important points.

We alth Analysis

Using ratios is far from the only way to assess the situation of an enterprise. An analysis of financial independence can also be carried out on the basis of property status. In fact, the greatest interest is the capital, which is already being transformed in the shortest possible time into another type of resource. So, it can turn into such benefits:

1. Workforce.
2. Means of production.
3. Time.
4. Money.

Capital goods that are displayed in the assets of the company's balance sheet and determine its current financial position. The analysis is carried out in two directions:

1. Internal. According to the content of articles, data on working capital ratios, payment schedule, notes.
2. External. In this case, attention is paid to the dynamics (growth) of active articles.

This approach allows you to carefully examine the situation with the enterprise and determine the real financial situation, the degree of influence of borrowed funds, and also approximately estimate how long it can exist in the absence of external cash flows (investments, loans, credits). If it is possible to achieve financial independence, then this ensures the stability of development and economic freedom of action. No one and nothing puts pressure on the enterprise, no conditions are created for the situation to worsen. And this, in turn, ensures long-term financial independence. In such conditions, it is much easier to reach new heights. In addition, data of this type can easily be used to reassure potential and existing investors about the good position of the enterprise.

About the autonomy factor

Earlier, indicators of financial independence were considered. Among them, there is one that should be given closer attention. This is the autonomy factor. For him, we will consider the formula. Financial independence can be either an assumption or a firm belief. The second option requires reinforcement in the form of mathematical calculations. The general formula is as follows: equity and reserves / total assets. To make practical use easier, let'sConsider how to work with balance sheet data. In the old way, you need to divide line 490 by 700. In a new way, 1300 / 1700 is already going on. Through such simple mathematical manipulations, you can quickly get the required value. As you can see, the autonomy ratio is both easy to calculate and allows you to get an idea of the chosen policy of the enterprise without getting acquainted with a lot of information.

What does the data mean?

The normative limit, as we know, is 0.5. Moreover, the higher the value obtained, the better the current financial condition of the enterprise. To deepen the analysis carried out, its value is compared with what is available on the average for the industry. If this coefficient is close to one, then this indicates that the pace of development of the commercial structure is restrained. After all, if you completely refuse to attract borrowed capital, then the organization loses a source of financing for the growth of its assets, thanks to which it is possible to increase the income received. At the same time, this is also a plus. Thus, such a situation can significantly reduce the risks of deterioration in financial solvency in the unfavorable development of the current situation. What are the other benefits of keeping it above 0.5? High financial stability allows you to look to the future with confidence. If all creditors simultaneously want their obligations to be repaid, the company will be able to cope with this requirement. If the coefficient is less than 0.5, thenan increase in assets is possible, but they will most likely be acquired on credit.

Conclusion

So we looked at what constitutes financial independence. This is the first step on the path to freedom. At the initial stage, there are always many applicants, but only a few go further. And no wonder. After all, if you want to become financially independent, you need to work hard for a long time. This is the path for at least years. There is no need to indulge yourself with the illusion that you can ensure your own comfortable existence in a few months - there will be less disappointment later. But those who can master it will receive not only a reliable financial basis for their activities and life, but also temper their own will, accustom themselves to financial self-discipline and make sure that everything was not in vain. And what to invest in:

1. Real production.
2. Services.
3. Financial assets.
4. Property.
5. Patents and inventions.

Everyone decides for himself. But, at the same time, one should remember one old Latin proverb: "Victory loves preparation."