Proprietary Ratio: Meaning, Formula, Significance and Examples

On the other hand, a lower ratio may suggest financial instability and prompt creditors to either reject loan applications or charge higher interest rates. 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.

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Proprietary Ratio Formula

A high itsdeductible 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.

Proprietary Ratio: Meaning, Formula, Significance and Examples

Establishes relationship between proprietor’s funds to total resources of the unit. Where proprietor’s funds refer to Equity share capital and Reserves, surpluses and Tot resources refer to total assets. A ratio value below 0.5 or 50% indicates that the business relies more on leveraged funds. This could indicate that the company is in significant debt, and its profitability may be affected.

But the problem is that the proprietary ratio is not an obvious indicator of whether or not a company is appropriately capitalized. This indicates that the company has a negative net worth and may be in financial distress. A negative ratio can also mean that the company has a high amount of debt financing relative to its equity financing, making it vulnerable to financial risks and reducing its creditworthiness. This shows that 60% of the company’s assets are funded by its equity, which suggests a stable financial position with less reliance on external debt.

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However, one would need to compare this ratio with other companies in the same industry to have a better understanding of TechCo Inc.’s relative financial health and risk. The proprietary ratio is a valuable financial metric that provides insights into a company’s reliance on shareholders’ equity for financing its assets. Investors and stakeholders use this ratio to assess the financial risk, solvency, and overall health of a company, making it a crucial tool in financial analysis and decision-making. Understanding the proprietary ratio aids in evaluating the capital structure and financial stability of a business. It empowers shareholders, creditors, and potential investors to assess the financial capability of a company to meet its long-term liabilities, revealing how much of the total funds are internal.

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. 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 may also express the relationship between proprietor’s funds, i.e., shareholder’s funds, and net assets or capital employed.

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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. A high ratio indicates that the company’s capital structure is strengthening, and the business is increasing its shareholders’ capital while decreasing its debt obligations. This also helps the firm to secure the credibility of the creditors, financiers, and investors.

• It empowers shareholders, creditors, and potential investors to assess the financial capability of a company to meet its long-term liabilities, revealing how much of the total funds are internal.
• The proprietary ratio is also known as the equity ratio or the net worth to total assets ratio.
• A company’s capital structure refers to the mix of debt and equity used to finance its operations.

Proprietors funds refers to the funds provided by equity shareholders and total assets refer to the combined funds of both debt (financing obtained from outside) and equity (shareholder or proprietors funds). A high proprietary ratio indicates that a large part of the assets are financed by owners and contributes to the company’s sustainability. On the contrary, a lower ratio may signify higher financial risk as it indicates greater reliance on external liabilities. However, the ideal ratio can vary significantly depending on the industry and the specific business model of the company. Some companies are more capital-intensive and may require more debt financing, leading to a lower Proprietary Ratio.