This ratio is also called ratio of net worth to total assets. This ratio sows the extent to which the shareholders shown the business. It is calculated as shown below:

Proprietary Ratio = Total Shareholders’ Funds/Total Assets

Components: Total shareholders’ equity is comprised of the total amount of equity share capital and preference share capital plus the total amount of reserves and surplus. The total assets section includes total of current and fixed assets. The intangible assets should be included only if these assets have nay realizable value. The fictitious items in the assets side like preliminary expenses, debit balance of profit and loss account etc., must be deducted form the accumulated balance of the Reserves and Surplus Account or the capital.

Uses of the ratio: The ratio is of particular importance to the investors because the presence of a high percentage of shareholders’ funds (including reserves and surplus) indicates that there is relatively little danger of winding up or forced reorganization in the event of default in payments to outside liabilities. Theoretically, then, the higher the proprietary ratio, the greater the long-run stability of the firm and consequently greater protection to creditors. However greater long-run stability does not always result in maximum profits for shareholders over a period of time and does not itself shown that the business is sound. A proprietary ratio of say 80% or 100 would not necessarily be good because sometimes funds from outsiders can be used to the long-run advantage of the business enterprise. This ratio is also a test of proper capitalization. For example, if the business is earning a profit of 20 per cent on funds it has borrowed at 10 per cent,  the shareholders are making a profit of 10 per cent on somebody’s else investment. This is technically referred to as trading on the equity. The conclusion is that for an efficient financial management, there should be optimum use of internal and external sources of funds. The proprietary ratio is also a test of credit strength. Since total assets equal total claims, it means that the proprietary ratio is really a test of the shareholders funds to total outside laities. Thus if the amount of shareholders’ funds decreases relative to the amount of loan capital (long and shot-term), the business becomes more dependent upon creditors to supply its working capital. This ratio, therefore, should be considered with current ratio.

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