Proprietary Ratio: Meaning, Formula, Significance and Examples
Financial Statements are prepared to know the profitability and financial position of the business in the market. These financial statements are then analysed with the help of different tools and methods. Ratio Analysis is one of the methods to analyse financial statements. The relationship between various financial factors of a business is defined through ratio analysis.
Proprietary ratio is the one that is used to express a relationship between the amount invested by proprietors in the business and the total assets owned by the business. In other words, the proprietary ratio measures the extent of assets funded by the proprietor’s funds. It denotes the percentage of assets funded by a shareholder’s fund in a business. The intent is to ascertain the risk involved and capital stability and also the cost of capital involved.
Proprietary ratio is one of the four main Solvency ratios. Solvency ratios are those ratios that measure an enterprise’s capability to meet its long-term obligations. Such measures are made using parameters, like the value of long-term debt, the assets available within the organisation, the funds invested in the firm, etc.
From a long-term point of view, a higher proprietary ratio is generally treated as an indicator of a sound financial position because it means that equity has been used to acquire a larger proportion of the total assets. It also implies that the firm is less dependent on external sources of finance. On the other hand, a lower proprietary ratio indicates that the long-term loans and other obligations are less secured and they can lose their money.
Proprietors Fund and Total Assets can be defined as:
- Proprietors’ Funds: These refer to the amount invested by the shareholders/owners in the business. It comprises two types of share capital: equity as well as preference share capital and is listed on the liabilities side of the Balance Sheet under the heading ‘Equity’.
- Total Assets: It is the conglomeration of all kinds of assets owned by the company; fixed (tangible and intangible), current, deferred revenue expenses, etc.
Proprietors’ Funds = Equity Share Capital + Preference Share Capital + Reserves and Surplus (Excluding fictitious Assets) + Money received against share warrants
Total Assets = Current Assets + Non- Current Assets(including deferred revenue expenses)
Proprietary ratio is very useful to the lenders, as it helps them ensure the safety of their investments by way of informing the level of dependence a corporation has on the outsiders’ funds. In simple words, a higher proprietary ratio is favourable since it depicts lower dependence on outsiders for funds, and hence, raises the firm’s credibility and creditors’ confidence. This facilitates easy and cheap credit whenever required. The chances of the firm going bankrupt also come down significantly.
Calculate the proprietary ratio of ABC Ltd. from the following Balance Sheet:
Proprietors’ Funds = Share Capital + Reserves and Surplus + Money received against share warrants + Profit as per Income Statement
= 10,00,000 + 8,00,000 + 6,00,000 + 5,00,000
Total Assets = ₹58,00,000
= 0.5:1 or 50%
Calculate the proprietary ratio from the following information:
Fixed Assets ₹10,00,000; Working Capital ₹5,00,000; Current Liabilities ₹2,00,000.
Proprietors’ Funds = Fixed Assets + Working Capital
= ₹10,00,000 + 5,00,000
Also, Working Capital = Current Assets – Current Liabilities
Current Assets = Working Capital + Current Liabilities
= 5,00,000 + 2,00,000
So, Total Assets = Fixed Assets + Current Assets
= 10,00,000 + 7,00,000
= 0.8:1 or 80%
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