Equity ratio is investment leverage or solvency ratio which is used to measure the number of assets which are financed by the owners’ investment. This ratio can be calculated by the total equity to total assets.
This ratio is used to highlight the 2 main financial concepts of sustainable business. From the first component, we know how much assets of the company is owned by investors. Whereas the second component shows how leveraged the company is with its debt.
Equity ratio calculates the number of the company’s assets financed by the investors. And the inverse of the calculation of this ratio shows the number of assets financed by debt. If the equity ratio of the company is high it means that investors have believed in this company and want to invest in this company.
Equity ratio formula is calculated by dividing the total equity by the total assets of the company. All the asset and equity of the company reported on the balance sheet of the company.
Equity Ratio = Total Equity/ Total assets
If the equity ratio of the company is high then it is favourable for the company. A high ratio shows that the company is less risky and more sustainable.
As compare to debt financing equity financing is cheaper because interest is related to debt financing. So the company which has a high ratio will have low financing and financial debt cost as compared to the company which has a low equity ratio.
There is the new company start by Watson with some investors. Watson wants for additional financing for the growth of the company for which he discusses with its partner. Total assets of his business are $150,000 and total liabilities are $50,000. Total equity of the company considers 100,000 dollars. then we can calculate the equity ratio as
Equity ratio = total equity/ total assets
Equity ratio = 100,000/150,000
From the equity ratio, it is clear that 67 % assets of the company owned by the shareholders, not by the creditor.
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