Proprietary Ratio Super Simplified Formula & Interpretation

The most significant assumption in the proprietary ratio is off-balance sheet financing. Now, you might wonder what off-balance sheet financing is.

Proprietary Ratio Formula = Total Equity/ Total Tangible Assets

Formula for Proprietary Ratio

If you were just looking for the formula, then you don’t need to read any further.

Instead, if you are looking for some deeper insights and also want to know why you never heard of this formula then read on

Interpretation of Proprietary Ratio

Propritary Ratio Formula
The proprietary ratio formula is total equity divided by tangible assets

If you look at this simply straight then, we are saying this:

“What proportion of tangible assets belong to the shareholders”

Meaning of Proprietary Ratio

Now, you may ask why does that matter? Well, it doesn’t and that’s why it the limited use.

However, if you want to look at the long term solvency of a particular company, then this might be a fancy way.

Look at the balance sheet below of Tata Steel;

Tata Steel balance sheet
Tata Steel

So, If we calculate then we get:

  • The proprietary ratio for this company then comes as (Share capital and Reserves and surplus)/ Fixed assets. Which comes out to be=1.0079.

But wait! What does that even mean? i.e 1.0079?

So, numerically all it means, is that shareholders’ equity is almost equivalent to fixed assets.

Reliance Industries Financials
Reliance Industries

So if we calculate the same ratio for reliance industries we get, 1.24.

Now, I will summarise the findings! Which, if you see that Reliance has lower debt compared to tata steel, but has a high proprietary ratio.

So, that means lower debt leads to a higher proprietary ratio! This makes total sense, after all, it is a proprietary ratio, right?

Assumptions in Proprietary Ratio

The most significant assumption in the proprietary ratio is off-balance sheet financing. Now, you might wonder what off-balance sheet financing is.

Let me explain this with an example;

Let’s suppose, I started a business for building garbage disposable bags. Also, the machine required to make these bags is available at a purchase price of $5000. Now, there are two methods by which, I could not only get this machine but also manage the leverage of the company.

  • Firstly, I could simply approach a bank and get a loan of 80% of $5000.
  • Secondly, we can tie up with a company that leases the same machine without buying it.Hence we fund and total assets remain same as before.

Hence, the first method would increase our debt in the company and make us look risky. However, in the second method, the only thing visible in our financial statements would be the rent.

So, this kind of financing won’t be captured in the proprietary ratio = Total tangible assets( Because was never owned)/ Equity( No change in equity ratio). So our capital structure would appear to be entirely equity.

Another assumption is that it doesn’t consider intangible assets.

Why analysts don’t use it?

For the same reason, what we experienced.

I mean why would you entangle your hands from behind your nose to catch the same nose?

Firstly debt to equity gives almost the same information as this ratio. Then why look for the same information again?

Similar Ratios like this

There are multiple such behind-the-nose ratios, which you could use to infer almost the same information under the category of

  • Leverage Ratio: Assets / Equity share capital, which is the reverse of the prop ratio. The higher this ratio the more leverage you have.
  • Debt to total capital: Debt/ (Equity+Debt), which is to find the proportion of debt to the total capital employed
  • Debt to Equity: Debt/Equity, which is how many times debt is compared to equity.

Moreover, all the above ratios, infer the same information.

Degree of Operating Leverage

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