The equity ratio is a financial metric that indicates the proportion of a company’s assets financed by shareholders’ equity rather than debt.
Primary Implication
The higher the investment levels by shareholders, the more investor confidence is shown in how they are financing the company.
A lower Equity Ratio means that more financing is being used to acquire assets, and as a result, higher debt service costs must be paid out of cash flow. Should your business get behind in servicing your debt, you put your equity investment in the business at higher risk.
Overview
The Equity Ratio is a Solvency Ratio that measures the amount of assets that are financed by owners’ investments. I.e., owned outright by the investors by comparing the total equity in the company to its total assets.
Inversely, it shows how leveraged the company is with debt. In other words, after all of the liabilities are paid off, the investors will end up with the remaining assets.
The formula for calculating the Equity Ratio is as follows:
Total Equity / Total Assets
An equity-to-asset ratio of 1 means that investors own 100% of the business assets. A ratio of 2-to-1 indicates that more equity funds than credit monies have been used to fund company assets.
Higher is Better: higher investment levels by shareholders show investor confidence in financing the company.
Lower is Worse: a lower equity ratio leads to more financing and higher debt service costs.