Corporate Finance For Dummies

Some companies are particularly interested in the proportion of their total assets that’s comprised of equity ownership because this ratio can decrease the amount that they have to borrow in order to generate the same amount of earnings.

Maintaining a high ratio of equity to total assets provides a degree of protection against the risk that interest payments will exceed earnings, particularly for companies that generate their earnings from interest on loans or rentals. Analysts calculate the equity to total assets ratio using this equation:

Here’s how to put this equation to use:

1. Use the balance sheets from the current year and previous year to calculate the average equity and average total assets:

• Add the total equity of the current year and previous year and divide the answer by 2; this is your average equity.

• Add the total assets of the current year and previous year and divide the answer by 2; this is your average total assets.

2. Divide the average equity by the average total assets to get the equity to total assets ratio.

Investors like to calculate this ratio because it provides indications that are similar to the debt to equity ratio. A lower ratio may mean that the company is funding its assets inefficiently if it’s paying a very high amount on interest expenses. A lower ratio may also mean that the company has very low net value for investors.