Proprietary Ratio

The proprietary ratio measures what portion of a company’s net assets is financed by the owners’ own money. It answers a simple question: of every rupee invested in the business (after deducting current liabilities), how much belongs to the shareholders?

Formula

Proprietary Ratio = Shareholders’ Funds / Capital Employed (or Net Assets)

Shareholders’ Funds include share capital, reserves and surplus, and any accumulated profits belonging to equity and preference shareholders. Capital Employed is the same as Net Assets — total assets minus current liabilities.

Worked example (based on Illustration 7 data)

Shareholders’ Funds = ₹15,00,000

Capital Employed = ₹20,00,000

Proprietary Ratio = ₹15,00,000 / ₹20,00,000 = 0.75 : 1

This means that for every ₹1 of net assets, 75 paise comes from the owners’ funds.

Significance

A higher proprietary ratio is a positive sign. It indicates that the company relies more on its own funds than on borrowed money. This provides greater security to creditors because the owners have a larger stake in the assets. If the business suffers losses, the owners’ capital absorbs the hit first, protecting lenders.

Alternative base

The ratio can also be computed using total assets instead of net assets (capital employed). The textbook uses net assets, but the logic remains the same — the numerator is always shareholders’ funds.

Key relationship with Debt to Capital Employed Ratio

There is an important check built into these two ratios. The proprietary ratio and the debt to capital employed ratio always add up to 1.

Debt to Capital Employed Ratio (from Illustration 7) = 0.25 : 1

Proprietary Ratio = 0.75 : 1

Total = 0.25 + 0.75 = 1

In percentage terms: 25% of capital employed is funded by debt and 75% by owners’ funds. This relationship holds because capital employed is financed entirely by either debt or equity — there is no third source.

What the ratio tells an examiner …