Proprietary Ratio

Proprietary ratio is a type of solvency ratio that is useful for determining the amount or contribution of shareholders or proprietors towards the total assets of the business.

It is also known as equity ratio or shareholder equity ratio or net worth ratio. The main purpose of this ratio is to determine the proportion of the total assets of a business that is funded by the proprietors.

Proprietary ratio can be used to evaluate the stability of the capital structure of a business or company and also show how the assets of a business are formed by issuing a number of equity shares rather than taking loans or debt from outside.

It also indicates how much the shareholders will receive in the event of liquidation of the company.

The proprietary ratio is expressed in the form of a percentage and is calculated by dividing the shareholders equity with the total assets of the business.

In a condition such as when the shareholders equity contributes to 100% or the complete assets of the company is financed by shareholders, it implies that no external debt was required for financing the business.

Also, equity capital is more expensive than the debt capital.

A high proprietary ratio indicates that a business is in a strong position and provides relief to creditors, while a low proprietary ratio shows the dependence of the company on the debt financing in order to run its business. It also indicates that creditors will lose interest for providing finance to such a company. Interest rates will become high and there is also a high risk of bankruptcy.

Calculation of Proprietary Ratio

Proprietary ratio or equity ratio can be calculated with the help of the following formula. It is represented as

Proprietary Ratio = Proprietors Funds / Total Assets

Where,

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).

Let us understand the calculation of proprietary ratio by using a solved example.

Solved Example

Q. ABC Pvt Ltd has a shareholder’s fund of 300,000 and total assets of 500,000. Find the proprietary ratio.

Answer:

We know that shareholders’ fund is also known as proprietors’ fund or the funds contributed by the owners in a company or a business.

Now,

Proprietary Ratio = Proprietors Funds / Total Assets

Here, Proprietors funds = 300,000

Total Assets = 500,000

Therefore, Proprietary Ratio = 300,000 / 500,000

= 0.6

When expressed in the form of a percentage, it comes to 60%. It means 60% funds of the business are financed by the proprietors.

This concludes our article on the topic of Proprietary Ratio, which is an important topic in Class 12 Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.

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