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Proprietary Ratio

Overview Of Proprietary Ratio

Proprietary Ratio is referred to by my names like Equity Ratio or Net Worth to Total Assets ratio as well as Shareholder's Equity to Total Equity Ratio. It is expressed in percentage and conveys the relationship between owner's funds and total resources deployed by a business. It is also an indicator of the total shareholder's funds which are used to fund the total assets of the company, or in other words the amount of capitalisation to run the business.

Proprietary Ratio (%) = Shareholder's Equity / Total Assets

Many analysts choose to consider only tangible assets and hence express the ratio as Shareholder's Equity divided by total assets less intangible assets like goodwill etc. Shareholder's Equity is also referred to as Proprietor's Funds.

Consider a numerical example of XYZ Company for illustration purposes

Assets

USD

Tangible Assets

1,200,000

Long-Term Investments

550,000

Stock

80,000

Trade Receivable

80,000

   

Liabilities

USD

Share Capital

1,300,000

 Reserves & Surplus

100,000

Short-Term Borrowings

70,000

Trade Payable

440,000

Proprietary Ratio = Shareholders' Funds/Total Assets

Shareholder's Funds = Share Capital + Reserves & Surplus

                                                = 1,300,000+100,000 = 1,400,000

Total Assets = 1,910,000

1,400,000/1,910,000

Proprietary ratio = 0.73

This means that 73 percent of the Company's total assets are funded by the shareholders. Notably off balance sheet debts are not considered while calculating this ratio however it does overstate the proprietary ratio. A high ratio typically is indicative of the owner's confidence in the business and that it has enough investments from the shareholders to run its operations. It also means that the company has some room for obtaining debt funding in case it requires to.

A low ratio means that majority of company's operations are being funded by external funding and this may make creditors a little wary. They would examine the ratio along with the company's cash flows and profitability to view its financial health. This would give them an idea as to the company's ability to service its debt. A right mix of debt and equity based on industry standard and company's nature of operations might do well in the long run.

What is a good proprietary ratio depends on shareholder's perception also. Having higher debt on the books means the company is leveraged and if the company has high cash flows it will mean that shareholders will have higher payoffs. Conservative investors would not prefer high debt on the books. In the initial years of business, company's especially those which are capital intensive will need huge amount of capital for their growth. However its ability to pay debt needs to be understood well. Debt servicing results in an actual cash outflow and hence the nature of the business, its operations and industry scenario all have an important bearing on analysing this ratio.

One needs to understand each financial statement in detail before performing ratio analysis.

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