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What is Proprietary Ratio?
What’s important to know about it?
In this article, I will break down the meaning of Proprietary Ratio so you know all there is to know about it!
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Let me explain to you what Proprietary Ratio is and why it’s important!
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What Is Proprietary Ratio
The proprietary ratio is a financial measure allowing you to assess the proportion of a company’s shareholder equity in relation to its total assets.
The proprietary ratio allows you to estimate the company’s capitalization used to fund the business.
When a company’s proprietary ratio is high, it means that it has enough equity to be able to support its ongoing business operations.
On the other hand, if the ratio is low, it means that the company may be using more debt to support its business than equity.
It’s important to consider the proprietary ratio along with other financial ratios such as the net profit ratio, plowback ratio, and other ratios to get a better picture of a company’s growth potential and solvency.
Keep reading as I will further break down the meaning of proprietary ratio and tell you how to calculate it.
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Why Is The Proprietary Ratio Important
The proprietary ratio is an important financial ratio as it allows investors and company stakeholders to assess the company’s financial stability.
The main objective of using this ratio is to see how much of a company’s total assets are funded by the proprietors (or shareholders).
Using the proprietary ratio, you can measure the stability of a company’s capital structure.
Is the company acquiring its assets using equity or is it taking loans or incurring debt?
The proprietary ratio will also give shareholders an indication of how much they stand to receive in the event of the company’s liquidation.
The higher the ratio, the more the shareholders will expect to receive in a liquidation payout (and vice versa).
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How To Calculate The Proprietary Ratio
To calculate the proprietary ratio, you need to use the following formula:
Proprietary Ratio = Proprietary Funds / Total Assets
Proprietary funds refers to the funds provided by the company’s shareholders.
Total assets refers to a company’s total assets on its balance sheet regardless of how it was funded (through debt or equity).
As you can see from the formula, you must take the amount of equity provided by equity shareholders and divide that by the company’s total assets.
This calculation will help you see the proportion of the company’s total assets that are funded by the proprietors versus other forms of financing.
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Proprietary Ratio Interpretation
The proprietary ratio helps you measure how much the company’s stockholders are contributing to the total capital of the company.
When you have a high proprietary ratio, it means that the company is in a good financial position.
Since it is funding most of its assets using shareholder equity, the company creditors will not be exposed to liquidity risk or default risk.
However, if the company’s proprietary ratio is low, it means that the company is heavily using debt for its operations.
If the company has too much debt, creditors may fear liquidity issues in case the company’s cash flows fluctuate or something happens to the company.
To get a better perspective of a company’s solvency and capital structure, you should use the proprietary ratio along with other financial measures such as the net profit ratio, dividend payout ratio, and others.
Also, you should consider the company’s cash flow statements to see if there are one-time events or other events that may have impacted the proprietary ratio.
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Proprietary Ratio Example
Let’s look at an example of a proprietary ratio to better understand the concept.
By looking at Company ABC’s financial statements, we can see that it has a shareholders’ equity of $5,000,000.
Also, on its balance sheet, it is showing $15,000,000 of assets.
Now, to calculate the proprietary ratio, we’ll need to take the company’s shareholders’ equity and divide it by its total assets.
In this example, the result is 33%.
This means that 33% of the company’s total assets have been funded by the company proprietors.
This ratio can be compared to competitors in the same industry, similar companies, or even look at trends over time.
If the company’s proprietary ratio is increasing over time, it means that the company is funding its business operations more and more through equity capital.
If the company’s proprietary ratio is low, investors and company stakeholders should further assess the company’s liquidity to see if the company presents solvency risks.
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So there you have it folks!
What does the proprietary ratio mean?
In a nutshell, the proprietary ratio is a type of solvency ratio allowing investors and financial analysts to determine how much equity shareholders are contributing to the business.
It is a solvency ratio as you are essentially measuring the strength of a company’s capital structure.
The proprietary ratio establishes the relationship between the funds provided by the “proprietors” and the company’s total assets.
A high proprietary ratio shows that a larger portion of the company’s assets is funded by equity shareholders and the company has a better solvency position (which is a favorable position for investors and creditors).
A low proprietary ratio shows that a larger portion of the company’s total assets is funded by debt thereby increasing the company’s default risk (which is not favorable for investors and creditors).
Now that you know what the proprietary ratio means and how it works, good luck with your research!
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