What is an equity ratio?
Equity ratio is a simple equation that measures the financial strength of a company. It divides a company’s total liabilities by its stockholders' equity, which is the funds put into the business by investors.
Where have you heard aboutequity ratio?
As an investor it’s likely you’ll have heard equity ratio discussed as part of the wider risk assessment of a business. It can also be applied to personal finances and is typically used to by lenders to measure an individual’s liabilities and assets when they apply for a loan.
What you need to know aboutequity ratio.…
Equity ratio displays the proportion of the assets financed by shareholders versus creditors and is a good indicator of the level of gearing or leverage used by a company. Gearging uses borrowed money to purchase assets, and typically costs the business more than shareholder investment as lenders charge higher interest rates.
As an investor you should be looking for companies with a high equity ratio. Companies with a higher equity ratio are in a stronger financial position and pose less risk, which means they pay less interest on any money that’s borrowed. Those with a lower equity ratio often find it harder to secure finance and, when they do, interest rates are higher.
Equity ratio is a term commonly used in Europe and Japan, whereas debt to equity ratio is more commonly used in the US.