High – This ratio indicates the relative proportions of capital contribution by shareholders in comparison to the total assets of a company. It is used as a screening device for financial analysis, a higher ratio, say more than 75% means sufficient comfort for creditors since it points towards lesser dependence on external sources. It also implies that the firm is less dependent on external sources of finance. On the other hand, a lower proprietary ratio indicates that the long-term loans and other obligations are less secured and they can lose their money.
The proprietary ratio does not disclose any clear data about the company but should know the holistic concept of this ratio. Which, if you see that Reliance has lower debt compared to tata steel, but has a high proprietary ratio. On the other hand, if the ratio is low, it means that the company may be using more debt to support its business than equity.
Proprietary Ratio Super Simplified Formula & Interpretation
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. A low proprietary ratio signifies that more use debt funds for purchasing total assets. By looking at Company ABC’s financial statements, we can see that it has a shareholders’ equity of $5,000,000.
- When you have a high proprietary ratio, it means that the company is in a good financial position.
- The ideal ratio of proprietary ratio depends on the nature of the business as well as the investor’s risk appetite.
- In simple words, a higher proprietary ratio is favourable since it depicts lower dependence on outsiders for funds, and hence, raises the firm’s credibility and creditors’ confidence.
- The proprietary ratio is also known as the equity ratio or the net worth to total assets ratio.
Solvency ratios are those ratios that measure an enterprise’s capability to meet its long-term obligations. Such measures are made using parameters, like the value of long-term debt, the assets available within the organisation, the funds invested in the firm, etc. Thus, shareholders have contributed 40% of all funds used in the business, with creditors contributing the remaining 60% of funds. This ratio can be monitored on a trend line or compared with the same metric for competitors to gain a better understanding of the outcome.
Proprietary Ratio Example
Proprietary ratio shows the proportion of total assets financed by proprietors’ funds. A high proprietary ratio indicates that a company uses more proprietors’ funds for purchasing total assets and maybe the company has room in its financial facility to assume more obligations. The proprietary ratio of 64% means, 64% of the total assets of the company are financed by proprietors’ funds. This means that 33% of the company’s total assets have been funded by the company proprietors. The proprietary ratio is calculated by dividing proprietors’ funds by total assets. The proprietary ratio helps you measure how much the company’s stockholders are contributing to the total capital of the company.
Now, to calculate the proprietary ratio, we’ll need to take the company’s shareholders’ equity and divide it by its total assets. 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. Proprietary ratio is the one that is used to express a relationship between the amount invested by proprietors in the business and the total assets owned by the business.
The proprietary ratio shows the latitude in which equity shareholders’ funds are invested in various types of company assets. This calculation will help you see the proportion of the company’s total assets that are funded by the proprietors versus other forms of financing. The proprietary ratio is a financial measure allowing you to assess the proportion of a company’s shareholder equity in relation to its total assets.
Proprietary Ratio Interpretation
The ideal ratio of proprietary ratio depends on the nature of the business as well as the investor’s risk appetite. Investors and analysts always like a higher ratio compared to a lower ratio. The result will be more accurate of the company’s valid condition if you exclude goodwill and intangible assets from the denominator.
In other words, the proprietary ratio measures the extent of assets funded by the proprietor’s funds. It denotes the percentage of assets funded by a shareholder’s fund in a business. The intent is to ascertain the risk involved and capital stability and also the cost of capital involved. The proprietary 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.
Interpretation of Proprietary Ratio
This ratio shows the proportion of total assets of a company which are financed by proprietors’ funds. It helps to determine the financial strength of a company & is useful for creditors to assess the ratio of shareholders’ funds employed out of the total assets of the company. A low proprietary ratio shows that a larger portion of the company’s total assets is funded by debt thereby increasing the company’s default risk (which is not favorable for investors and creditors).
A company should mix and balance its external and internal sources in a way that none of them is too high in comparison to the other. 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. But the problem is that the proprietary ratio is not an obvious indicator of whether or not a company is appropriately capitalized.
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 should be used in conjunction with the net profit ratio and an examination of the statement of cash flows to gain a better overview of the financial circumstances of a business. These additional measures reveal the ability of a business to earn a profit and generate cash flows, respectively. The proprietary ratio components are shareholders’ or proprietary funds and total assets, including goodwill, etc. The proprietary ratio is also known as the ‘equity ratio’ which indicates the portion of total assets being held by a company that is funded by the proprietors’ funds.
Hence, the first method would increase our debt in the company and make us look risky. However, in the second method, the only thing visible in our financial statements would be the rent. If the company’s proprietary ratio is low, investors and company stakeholders should further assess the company’s liquidity to see if the company presents solvency risks. Also, you should consider the company’s cash flow statements to see if there are one-time events or other events that may have impacted the proprietary ratio. When you have a high proprietary ratio, it means that the company is in a good financial position.
Formula to Calculate Proprietary Ratio
Keep reading as I will further break down the meaning of proprietary ratio and tell you how to calculate it. Let’s look at an example of a proprietary ratio to better understand the concept. The higher the ratio, the more the shareholders will expect to receive in a liquidation payout (and vice versa). Let’s suppose, I started a business for building garbage disposable bags. Also, the machine required to make these bags is available at a purchase price of $5000. Now, there are two methods by which, I could not only get this machine but also manage the leverage of the company.
