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:
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:
The information about stockholders’ equity and assets is available from balance sheet.
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.
8 Comments on Proprietary ratio
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.
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