Proprietary ratio

The proprietary ratio (also known as net worth ratio or equity ratio) is used to evaluate the soundness of the capital structure of a company. It is computed by dividing the stockholders’ equity by total assets.

Formula:

proprietaryratio-img1

Some analysts prefer to exclude intangible assets (goodwill etc.) from the denominator of the above formula. In that case, the formula would be written as follows:

proprietaryratio-img2

The information about stockholders’ equity and assets is available from balance sheet.

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Example:

Total assets: $950,000

Intangible assets: $150,000

Stockholder’s equity: $440,000

From the above information we can compute proprietary ratio as follows:

(440,000 / 800,000 ) × 100

55%

The proprietary ratio is 55%. It means stockholders’ has contributed 55% of the total tangible assets. The remaining 45% have been contributed by creditors.

Significance and interpretation:

The proprietary ratio shows the contribution of stockholders’ in total capital of the company. A high proprietary ratio, therefore, indicates a strong financial position of the company and greater security for creditors. A low ratio indicates that the company is already heavily depending on debts for its operations. A large portion of debts in the total capital may reduce creditors interest, increase interest expenses and also the risk of bankruptcy.

Having a very high proprietary ratio does not always mean that the company has an ideal capital structure. A company with a very high proprietary ratio may not be taking full advantage of debt financing for its operations that is also not a good sign for the stockholders.

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8 Comments on Proprietary ratio

  1. Gokulakrishnan KH

    This ratio helps lenders in their decision making as to whether to lend or not. Let the proprietary ratio be 85%, which means 85% of the capital is invested in tangible assets. The lender can recover the funds by selling the tangible assets, if warranted. If it is 45%, the lender needs to think twice before extending the loan, as only 45% of the capital is invested in tangible assets.

    1. Pritam

      Thank you. Nice explanation.

  2. Debajit Borboruah

    An appropriate note

  3. Hema

    Thanku for the explanation

  4. Kado Elijah Kwaku

    thank you for this great and brief explanation

  5. Laxmi Ghongade

    Nice explanation…..THANKS

  6. Laxmi

    Thanks for explanation….

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