Covering margin

 

What is Covering Margin ? 

 

This KPI (Key Performance Indicator) is a margin who expresses the absolute value of the enterprise’s asset structure in covering fixed investments by means of equity capital.

The covering margin is also referred to as the Equity less non-current assets. However the terminology may vary, its meaning "covering margin" gives to the world of creditors and investors the first basic information on the soundness and stability of the enterprise's long term investments. As a fact of the matter its value indicates the company's ability to cover fixed investments (fixed assets) with its own means (net equity).

This KPI is an indicator typically used for solidity analysis in which the main purpose is to assess the sustainability of the company within the equity-financial balance or to understand the characteristics of its structural solidity. In fact, it is precisely the analysis of solidity that aims to understand whether the company is managed in an acceptable balance sheet and therefore the coimpany's solvency in the medium to long term.

Even though it must be considered that enterprises typically get external funding to carry out the business activity so that it is highly rare to find out a positive value of the covering margin among different industries, expecially when enterprises have good profitability ratios and generate positive operating cash flows. 

In the cases when the covering maring is positive, the ratio indicates that the amount of equity invested by the shareholders (shareholders’ equity) completely covers the net investment of fixed assets which means financial solidity of the company.

 

 

How to calculate the Covering Margin ?

 

Considering that it takes into account two variables coming from the balance sheet, its value can be obtained with a classic and very simple formula. In fact, the covering margin is the difference between the equity invested (net equity) and the fixed investments (capital employed in the company for long terms: so called "fixed assets"). Therefore, the Covering Maring does not require any particular reclassifications since the two main parametres are already shown in the Company's balance sheet.

 

> EQUITY - FIXED ASSETS <

 

 

What is the Covering Margin for ?

 

This KPI indicator is used for structural analysis and analysis of solidity, also called margin analyzes, and for the matrix analyzes that have always been used for the Internal Rating Based Systems of Banks (IRBS) following the introduction of Basel 2.

Being an absolute value, when it is positive it certifies that the company's shareholding structure fully covers its fixed assets (long term investments) and, residually, also can covering current assets. This very positive situation means that the company is fully solid, on the other hands it has sufficient assets to generate long term sustainability.

In fact, reported balance sheet indicates whether the choices relating to the use of sources of capital in covering financial needs have been balanced. Accordingly with major doctrine, a company will be balanced in terms of capital if it uses slow or zero rotation sources of capital (such as equity + consolidated liabilities also called "sources of permanent capital") for fixed assets (long-term slow rotation cycle "investments") and sources of financing with fast rotation (such as short-term debts) in order to cover current assets (loans with fast rotation cycle).

Capital solidity is therefore the company's ability to bear unforeseen negative internal or external events and for this reason the margin indicator is often used by creditors and lenders of the company who intend to evaluate the risk management opportunity to hedge risks with different instruments.

 

On a Risk Management perspective, as long as Credit Risk Analysis are typically interested to know the capital strengths, soundness and solidity of one's enterprise, it shall be taken into account that there are several KPI indicators that may be outcome from the reporting. Following this analysis by using margins, the main KPI are the followings: 

 

  1. Covering margin,
  2. Long-term Investments covering margin,
  3. Net Working Capital,
  4. Treasury Margin

 

Finally, this analysis on the capital structure and financial balance of long term investments can be carried out through the Equity to Fixed Assets Ratio (EAR) which is the expression in percentage terms of the covering margin. As a fact of the matter, a trustworthy analysis can be used in Credit Risk Management by using ratios (quotients) which in this particular case would be: 

 

  1. Equity to Fixed Assets Ratio (EAR)
  2. Long Term Financing to Equity ratio
  3. Quick ratio
  4. Current ratio

UNIGIRO is a regtech facilitator. Its dynamic and extensive Key Performance Indicators (KPI) boost real-time monitoring of financial sustainability upgrading risk management regtech tools and corporate social governance.

MONITORING ENTERPRISE CREDIT RISK: the first Smart XBRL Data Analytics Engine Toolkit for Financial Risk Analysis that facilitate Creditors and Investors in monitoring company's creditworthiness and financial sustainability

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