How to calculate equity ratio, step by step
The equity ratio is one division that answers one question: what share of everything the business owns is funded by its owners? A business that knows the answer can see how much of what it owns belongs to the owners and how much is owed to lenders. The calculation is total equity divided by total assets — two numbers from any business’s balance sheet, divided. The answer is a percent: a ratio of 60.00% means 60 cents of every asset dollar is funded by the owners, and the rest is funded by borrowing.
The formula is equity ratio = total equity ÷ total assets. Total equity is what the owners have put in and what the business has kept — the share capital plus the retained earnings. Total assets is everything the business owns — the cash, the stock, the equipment, the property and the other assets on the balance sheet. Both figures come from the same balance sheet, in the same currency, on the same date, or the ratio is wrong before it starts.
The worked example, line by line. Step 1 — the total equity: $600,000. Step 2 — the total assets: $1,000,000. Step 3 — the division: $600,000.00 ÷ $1,000,000.00 = 60.00%. Step 4 — the meaning: 60 cents of every asset dollar is funded by the owners. As a decimal the same ratio is 0.6000 — the percent and the decimal are two ways of writing the same number, never the same figure: 60.00% is the share, 0.6000 is the fraction. Work it yourself in the equity ratio calculator.
What the number means
A ratio of 60.00% means 60 cents of every asset dollar is funded by the owners, so the owners fund more of the business than the lenders do. A lower ratio means less owner funding: the business leans on borrowing, and a bad year still leaves the interest to pay. A higher ratio means more owner funding: the business leans on its owners, and a bad year hurts the owners first. The ratio on its own never says whether 60.00% is strong or weak — that depends on the business and its industry. A business with steady cash flow can run on a lower ratio because the borrowing is easy to service, and a young business with lumpy income can struggle at the same ratio. What the ratio does say, plainly, is how much of everything the business owns is funded by its owners.
What moves the equity ratio
Two things move the ratio: the equity and the assets. Raise the total equity and the ratio rises, because a bigger share of the same assets is owner-funded: with assets held at $1,000,000, equity of $500,000 puts the ratio at 50.00%, and equity of $750,000 puts it at 75.00% — the smallest total equity for the ratio to reach 50% is $500,000, and the smallest total equity for it to reach 75% is $750,000. Cut the equity — a loss, or a dividend paid out — and the ratio falls. Raise the total assets and the ratio falls, because the same equity is now a smaller share of a bigger asset base: buying equipment or stocking up both push the ratio down without a dollar of equity leaving the business. Cut the assets — selling equipment, or running down stock — and the ratio rises, because the same equity is now a bigger share of a smaller asset base.
When the ratio is undefined
If the total equity and the total assets are both $0, the ratio is undefined — total assets are $0, and dividing by $0 has no answer. A business with no assets at all has no ratio to calculate, only a warning. If the total equity is $0, the ratio is 0.00% — a real figure, not undefined: nothing of the assets is owner-funded. If the total assets are $0 while the equity is not, the ratio is undefined too — there is nothing to divide by, so there is no share to report. A negative equity figure is possible when losses have eaten past the owners’ stake, and then the ratio is negative — a real figure, not undefined — the owners owe more than they own.
Common mistakes
The first mistake is confusing this ratio with the equity multiplier — that one divides total assets by total equity, the inverse of this ratio, a leverage multiple, not a share of the assets. The same $600,000 of equity and $1,000,000 of assets give an equity multiplier of 1.67x, and mixing the two up turns a share into a multiple. The second is confusing it with the debt-to-capital ratio — that one divides total debt by total capital, the debt share of the funding, not the equity share of the assets. The third is mixing dates — the equity from one balance sheet divided by the assets from another is not a ratio at all. The fourth is using only the assets you can see — total assets means all of it, cash and stock and equipment and property, or the ratio overstates the owners’ share. Work it out in the equity ratio calculator, and check the equity multiplier calculator and the debt-to-capital ratio calculator before you decide what the funding means.