Finance:Equity ratio

The equity ratio is a financial ratio indicating the relative proportion of equity used to finance a company's assets. The two components are often taken from the firm's balance sheet or statement of financial position (so-called book value), but the ratio may also be calculated using market values for both, if the company's equities are publicly traded.

Interpretation

The equity ratio is a good indicator of the level of leverage used by a company. The equity ratio measures the proportion of the total assets that are financed by stockholders, as opposed to creditors. 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.

Relationship to debt ratio

The equity ratio is closely related to the debt ratio, since both are derived from the balance-sheet identity that total assets are financed by a combination of liabilities and shareholders' equity.

When total liabilities and total equity are the only financing sources considered, the equity ratio and debt ratio are complementary measures. A higher equity ratio implies a lower proportion of assets financed by debt, while a lower equity ratio indicates greater reliance on creditor financing and therefore greater financial leverage.