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What is the Asset/Equity Ratio?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 15 March 2014
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    Conjecture Corporation
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The asset/equity ratio is one of the standard formulas used to ascertain the overall financial stability of a company. In essence, the function of this ratios is to determine the value of the total assets of the company, less any portion of the assets that are owned by the shareholders of the corporation. The amounts of assets that are owned by the shareholders is often referred to as owners equity or shareholder equity, and are often not considered as eligible for collateral when the corporation is attempting to secure a business loan.

There are a couple of reasons why understanding the current status of the asset equity ratio is important to the ability of a company to operate. First, the asset/equity ratio can tell a great deal about the current operation of the company. A company that has relatively few assets that are completely owned and controlled by the company, but has outstanding debt that is equal to or exceeds the worth of the assets, would not be considered a good investment. At the same time, a company with a strong body of assets and relatively little debt may be a very good investment. However, it is important to note that low debt and strong assets may also indicate a company that is very conservative and may be opposed to growth strategies. Investigation begins with a look at the asset/equity ratio, but further investigation is always a good idea before investing in any company.

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Second, this ratio can be the starting place for securing a business loan, either for improvements to existing operations, or expansion of the company in some manner. An high asset/equity ratio indicates the company may be suitable for the extension of credit, especially is the amount of debt carried by the company is somewhat low, or if the company has a proven track record of paying installments on time.

There is not really an ideal asset/equity ratio that will provide a complete snapshot into the financial health of a company. The status of the asset/equity ratio simply provides some basic information that will serve as a beginning point in evaluating the worth of the business. Obviously, a company with few assets and a lot of debt is not generally a good risk. However, lots of assets and low debt may indicate other issues that could make the investment unwise. Using the information obtained from calculating the asset/equity ratio, it is possible to responsibly evaluate the overall status of a business, and determine if the company is a good risk.

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anon107609
Post 3

Liquidity of a firm where current assets exceeds current liability would mean that certain long term sources (could be either capital or loan) has been invested in current assets.

And the issue of total ownership of fixed assets under such conditions would seem as if the firm is raising long term funds to pay off short term liabilities. And a high loan would no doubt clarify that the firm will surely stabilize its negative liquidity in the long run.

anon107214
Post 2

Yes--but it extends further than that. Outstanding debt can be any debt the company has acquired. So, if a company has $100k in assets and $200k in loans, that wouldn't be good in this equation (even if there are only asset loans for, say, 50k...the extra 150k in loans could be for capital, inventory, etc).

However, intangible assets, such as annual revenue, etc, can also be big indications of why debt was incurred. For example, given my above numbers, if that company was doing $1 million in revenue, the $200k in outstanding loans would look relatively impressive.

khally
Post 1

A company that has relatively few assets that are completely owned and controlled by the company, but has outstanding debt that is equal to or exceeds the worth of the assets, would not be considered a good investment.

Is the outstanding debt the money from which the Bank loaned to finance the assets? Right?

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