The Equity Ratio is one of several significant financial formulas within the family of Leverage Ratio s. It is calculated by dividing total equity by total assets, to produce a ratio or decimal which shows what proportion of a business’ assets are currently financed by equity.
Equity Ratio Formula:
Equity Ratio = total equity / total assets
Total equity: Total equity is a value calculated from your company’s balance sheet. It is liabilities subtracted from total assets.
Total assets: Total assets is the sum of all cash stores, accounts receivable, inventory, equipment, and anything else of value owned by your business. It can be calculated from your balance sheet by adding together fixed and current assets.
Balance sheet: A core financial statement that records a snapshot of a company’s assets, liabilities, and equity at the time of publication. For more information about the balance sheet, read our helpful blog post!
What can the equity ratio tell me about my business?
The equity ratio tells you the proportion of your company’s assets that are financed by equity, and therefore how leveraged your company is.
When you divide total equity by total assets, you’ll get a decimal that indicates how much of your total assets are funded by equity. A higher number (closer to 1) tells you that a larger proportion of your assets has been financed by equity. A higher equity ratio is considered more financially stable (since you’ve taken on less debt), and your business may look more appealing to banks and investors.
A lower equity ratio (closer to 0) indicates that a higher proportion of assets has been financed by debt. The more debt, the more leveraged the company looks. Because more debt tends to equal more financial risk, a lower equity ratio tends to be less appealing to lenders.
Generally, a business with an equity ratio below .5 is considered leveraged, as it currently has more debt than equity. A ratio above .5 is considered more conservative, as the company has more assets funded by equity than debt.
But there are exceptions to every rule. As we mentioned when discussing the debt ratio , leveraging smartly can help a company grow. Therefore, too conservative (high) of an equity ratio may indicate that a business owner is playing things too safely.
Acceptable equity ratios can vary depending on your business model and industry. Compare your equity ratio with other companies of your size within your industry to get a sense of whether or not your equity ratio is within the average.