Proprietary Ratio: Definition & Interpretation





What is a proprietary Ratio?

The proprietary ratio is also known as 'equity ratio' that reflects the portion of total assets being held by company which is funded proprietors' funds. 

This ratio establishes a relation between the 'proprietors' fund and total assets of the company. It helps to test the ability of the firm regarding its long term solvency and financial strength of a company.
          
Properters' funds are known as equity shareholders' fund, net worth etc.


Proprietary Ratio Formula

The proprietary ratio is calculated by dividing proprietors' funds by total assets.
          
Proprietary Fund= (Proprietors' Fund/Total Assets)

Where, proprietors' funds includes share capital & reserve(share capital + reserve)
          
Total assets includes long term assets & short term assets.

Proprietary Ratio Example

               

It is ABC company. Here is some information about the ABC company.

Balance sheet of ABC company as on 31.03.2019
             

            Proprietary ratio= (9,30,000/14,35,000)
                                           = 0.64 or 64%

It means, 64% of total assets of the company are financed by proprietors' funds.


Proprietary Ratio Interpretation

Proprietary ratio shows the latitude of which equity shareholders funds are invested in various types of company's assets. It measures the financial stability of the company.
          
A higher proprietary ratio reveals that a company uses more proprietors' funds for purchasing total assets. High ratio is a good sign to the investors. 

A lower proprietary ratio indicates that the more uses debt funds for purchasing total assets. It also shows a huge portion of debts in the total assets may minimize the creditors interest and increase the finance costs. Therefore, the company has a chance to become a bankruptcy. A lower ratio is unfavorable to the investors.
           
So, investors and analysts always prefer higher ratio than lower ratio. It is to be more useful when compare companies within same sector and find out a trend of past few years proprietary ratio. Estimating proprietary ratio gives valuation information when it is helped by debt to equity ratio.

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