Proprietary Ratio
The proprietary ratio, which is often referred to as the equity ratio, is the percentage of shareholders’ equity to total assets. As such, it offers a general approximation of the amount of capitalization that is presently being used to fund a corporation. If the ratio is high, it shows that a company has a sufficient amount of equity to support the functions of the business, and it probably has room in its financial structure to take on additional debt if necessary.
If the ratio is low, it shows that the company does not have sufficient equity to support the functions of the business. On the other hand, if the ratio is low, it suggests that a firm is supporting its operations with a disproportionate amount of debt or trade payables rather than equity (which may place the company at risk of bankruptcy).
Therefore, the equity ratio serves as a broad measure of the stability of the financial situation. To get a more complete picture of the financial status of a company, this metric, along with the net profit ratio and the analysis of the statement of cash flows, is the best way to utilise your business’s financial information. The capacity of a company to make a profit and produce cash flows are shown by these extra indicators, respectively.
Simply divide the entire amount of shareholders’ equity by the total amount of assets to arrive at the proprietary ratio. If you remove goodwill and intangible assets from the denominator, the findings will be a better reflection of the actual state of affairs at the firm.
The more restrictive version of the formula is:
Shareholders’ equity ÷ Total tangible assets
The significance of the proprietary ratio, as well as its interpretation, lies in the fact that it reveals the shareholders’ respective contributions to the total capital of the firm. Therefore, a high proprietary ratio implies that the firm is in a good financial position, and it provides better protection for the company’s creditors.
If the ratio is low, it shows that the firm is already dependent on its loans to a large extent for its operations. A significant amount of debt in relation to the total capital might cause creditors’ interest to decrease, as well as a rise in interest expenditures and the possibility of insolvency.
Even if a firm has a very high proprietary ratio, this does not always indicate that it has the most efficient capital structure possible. If a firm has a very high proprietary ratio, it is possible that it is not making the most of the opportunities presented by debt financing for its operations. This is not a positive indicator for the investors of the company.