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.
Equity Ratio = Total Owner's Equity / Total Assets
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.)
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