Proprietary Ratio | Equity Ratio
Description: The proprietary ratio (also known as the equity ratio) is the proportion of shareholders' equity to total assets, and as such provides a rough estimate of the amount of capitalization currently used to support a business. If the ratio is high, this indicates that a company has a sufficient amount of equity to support the functions of the business, and probably has room in its financial structure to take on additional debt, if necessary. Conversely, a low ratio indicates that the business may be making use of too much debt or trade payables, rather than equity, to support operations (which may place the company at risk of bankruptcy).
Formula: To calculate the proprietary ratio, divide total shareholders' equity by total assets. The results will be more representative of the company's true situation if you exclude goodwill and intangible assets. from the denominator. The more restrictive version of the formula is:
Shareholders' equity
Total tangible assets
Example: ABC Company has shareholders' equity of $2,000,000 and total assets of $5,000,000. There is no goodwill on its balance sheet, nor any intangible assets. Its proprietary ratio is:
$2,000,000 Shareholders' equity
$5,000,000 Total tangible assets
= 40% Proprietary ratio
Thus, shareholders have contributed 40% of all funds used in the business, with creditors contributing the remaining 60% of funds.
Cautions: The proprietary ratio is not a clear indicator of whether or not a business is properly capitalized. For example, an excessively high ratio can mean that management has not taken advantage of any debt financing, so the company is using nothing but expensive equity to fund its operations. Instead, there is a balance between too high and too low a ratio, which is not easy to discern.
Also, the ratio is not necessarily a good indicator of long-term solvency, since it does not make use of any information on the income statement, which would indicate profitability or cash flows.
Similiar Terms
The proprietary ratio is also known as the equity ratio or the net worth to total assets ratio.
Similar Ratios
Debt to assets ratio
Debt to equity ratio
Gearing ratio