how to calculate proprietary ratio step by step guide with formula by zerobizz

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' that 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 or solvency and financial stability of a company.

Proprietary Ratio Formula

The proprietary ratio is calculated by dividing proprietors' funds by total assets.

Formula: 1

Proprietary Fund= (Proprietors' Fund / Total Assets)

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:

Proprietary Fund= (Proprietors' Fund / Intangible Assets)

The first thing is to remain the same that is proprietors' funds include share capital, reserves and surpluses.

Proprietary Ratio Example

proprietary ratio explained in simple words by zerobizz

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's 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 obligation. 

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 to be more valuable when comparing companies within the same sector and find out a trend of the last few years' proprietary ratios. 

Estimating 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 analyze multiple numbers of ratios.

FAQs

What are proprietary funds?

The proprietary funds are known as equity shareholders' fund, net worth etc.

What are the Components of the proprietary Ratio?

The components of the proprietary ratio are shareholders' funds or proprietary funds and total assets include 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.

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