The proprietary ratio is one type of solvency ratio that is not used like commonly used ratios and very few investors use the proprietary ratio.
The proprietary ratio does not disclose any clear data about the company but should know the holistic concept of this ratio.
Proprietary Ratio Definition
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.
It also assesses the strength of the capital structure. This ratio is the inverse of the debt to asset ratio.
The proprietary ratio establishes a relation between the 'proprietors' fund and the total assets of the company. It helps to test the capacity of the firm regarding its long-term solvency and financial stability of a company.
Proprietary Ratio Formula
The proprietary ratio is calculated by dividing proprietors' funds by total assets.
Formula: 1
Proprietors' funds include share capital, reserves and surpluses as per the balance sheet.
Total assets include long-term assets & short-term assets include goodwill etc as per the balance sheet.
Formula: 2
The result will be more accurate of the company's valid condition if you exclude goodwill and intangible assets from the denominator.
The better restrictive edition of the formula is:
The first thing is to remain the same that is proprietors' funds include share capital, reserves and surpluses.
Proprietary Ratio Example
It is an ABC company. Here is some information about the ABC company.
The balance sheet of ABC company as on 31.03.2019
| Particular | Amount (Rs.) |
|---|---|
| Non-current assets | |
| Fixed assets | 425,000 |
| Long term investments | 390,000 |
| Total non-current assets | 815,000 |
| Current assets | |
| Cash in hand | 20,000 |
| Bills receivable | 50,000 |
| Inventory | 250,000 |
| Prepaid expenses | 100,000 |
| Short term loans | 200,000 |
| Total current assets | 620,000 |
| Total assets | 14,35,000 |
| Equity | |
| Share capital | 600,000 |
| Reserve | 330,000 |
| Total equity | 930,000 |
| Non-current liabilities | |
| Debentures | 200,000 |
| Long-term loans | 150,000 |
| Total non-current liabilities | 350,000 |
| Current liabilities | |
| Bills payable | 50,000 |
| Overdraft | 100,000 |
| Short-term loans | 5,000 |
| Total current liabilities | 155,000 |
| Total equity and liabilities | 14,35,000 |
Proprietary ratio = (9,30,000 / 14,35,000)
Proprietary ratio = 0.64 or 64%
The proprietary ratio of 64% means, 64% of the total assets of the company are financed by proprietors' funds. (We have taken the first formula).
Proprietary Ratio Interpretation
The proprietary ratio shows the latitude in which equity shareholders' funds are invested in various types of company assets. This ratio gauges the financial strength of the company.
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.
A higher ratio better is than the long-term solvency position of the company and also a high ratio is always favourable to the investor.
A low proprietary ratio signifies that more use debt funds for purchasing total assets.
It also shows a huge portion of debts in the total assets may minimize the creditor's interest and increase the finance costs.
Thus, the company has a chance to become bankrupt. A lower ratio is unfavourable to the investors. Investors and analysts always like a higher ratio compared to a lower ratio.
It is more valuable when comparing companies within the same sector and finding out a trend of the last few years' proprietary ratios.
Estimating the proprietary ratio gives valuation information when it is assisted by the debt-to-equity ratio.
But the problem is that the proprietary ratio is not an obvious indicator of whether or not a company is appropriately capitalized. That is why it is very significant to analyse multiple numbers of ratios.
FAQs
What are proprietary funds?
The proprietary funds are known as equity shareholders' funds, net worth etc.
What are the Components of the proprietary Ratio?
The proprietary ratio components are shareholders' or proprietary funds and total assets, including goodwill, etc.
Shareholders' funds include equity share capital, reserves and surpluses.
What is the ideal ratio for the proprietary ratio?
The ideal ratio of proprietary ratio depends on the nature of the business as well as the investor's risk appetite.
Analysts should be monitored on a trend line to gain a reasonable understanding of the ratio. The higher ratio is more reasonable than the lower.
