Equity Ratio

What is Equity Ratio?

The equity ratio is a financial metric that measures the amount of leverage used by a company. It uses investments in assets and the amount of equity to determine how well a company manages its debts and funds its asset requirements.

Formula for Equity Ratio

The formula for Equity Ratio is:

Equity Ratio = Total Equity / Total Assets

Where:

• Total Assets (current and non-current) are found on the company’s balance sheet.
• Total Equity (shareholders’ equity) is calculated as Total Assets – Total Liabilities.

Suppose you’re analyzing a company’s financial statements and ratios. You gather the following information from the balance sheet:

• Total Assets (current and non-current) = $50,000
• Total Shareholders’ Equity = $22,000

Using the Equity Ratio formula:

Equity Ratio = $22,000 / $50,000

Equity Ratio = 0.44 x 100 = 44%

This result means that 44% of this company’s assets are financed by shareholders, while the remaining 56% are financed by debt. It holds slightly more debt ($28,000) than it does equity from shareholders, but only by $6,000.

Importance of an Equity Ratio Value

Any company with an equity ratio value of 0.50 or below is considered a leveraged company. The higher the value, the less leveraged the company is. Conversely, a company with an equity ratio value of 0.50 or above is considered a conservative company because they access more funding from shareholder equity than they do from debt.

Investors tend to look for companies that are in the conservative range because they are less risky; such companies know how to gather and fund asset requirements without incurring substantial debt. Lending institutions are also more likely to extend credit to companies with a higher ratio. The higher the ratio, the stronger the indication that money is managed effectively and that the business will be able to pay off its debts in a timely way.

A high ratio value also shows that a company is, all around, stronger financially and enjoys a greater long-term position of solvency than companies with lower ratios.

Frequently Asked Questions About the Equity Ratio

What is the equity ratio formula?

The equity ratio formula is: Equity Ratio = Total Equity / Total Assets. Total equity includes shareholders’ equity, and total assets include both current and non-current assets. These figures are found on the balance sheet.

What does the equity ratio tell you?

The equity ratio tells you how much of a company’s assets are financed through shareholder equity versus debt. This metric helps investors and lenders assess financial leverage and risk.

What is a good equity ratio?

A good equity ratio is typically 0.50 or above as it indicates a company relies more on shareholder equity than debt to fund its assets. Investors and lenders consider companies with higher equity ratios as financially stable because they carry lower financial risk.

Additional Resources

Thank you for reading CFI’s guide to Equity Ratio. To keep advancing your career, the additional CFI resources below will be useful:

• Cost of Equity
• Current Assets
• Debt vs Equity Financing
• Leverage Ratios
• Operating Ratio
• See all Valuation resources