Definition
A financial ratio that measures the level of leverage used by a company, the equity ratio quantifies the proportion of the total assets that are financed by stockholders, and not creditors (or debt). The equity ratio only requires two inputs, owner's equity and total assets; both of which are found on a company's balance sheet.
Calculation
Equity Ratio = Total Owner's Equity / Total Assets
Explanation
Also known as the shareholder's equity ratio, there are two distinct schools of thought as to how to interpret the results of this metric.
Optimistic Outlook: A low equity ratio will produce good results for stockholders, as long as the company earns a rate of return on assets that is greater than the interest rate paid to creditors.
Pessimistic Outlook: A high equity ratio provides security to shareholders in the event a company is liquidated, since most of the assets are financed by equity and not by debt. (Remember, debt holders are paid first during bankruptcy proceedings.)
Example
Company A's balance sheet indicates total stockholder equity of $15,420,000 and total assets of $31,616,000. The equity ratio for Company A would be:
= $15,420,000 / $31,616,000, or 0.49
Related Terms
Also known as a statement of financial position, the balance sheet is used to show the financial health of a company at a particular point in time. The balance sheet consists of assets, liabilities, and owner's equity in the company. It is one of the four key financial statements issued by public companies.
Moneyzine EditorNovember 6th, 2024- The financial accounting term owner's equity is used to describe the resources that are owned by the common and preferred stock shareholders of a company. Owner's equity is reported on a company's balance sheet.Moneyzine EditorNovember 6th, 2024
The accounting term used to describe an economic resource, which is owned by the corporation and expected to provide future benefits to its operation, is asset. Appearing on the balance sheet, assets are typically broken down into two categories:Moneyzine EditorNovember 6th, 2024
The financial term leverage refers to the use of debt to increase the total profits returned to the company's equity holders.Moneyzine EditorNovember 6th, 2024
