Finrepo » Company's Financial Accounting » Financial Analysis of the Company. Main Indicators » Capital Structure Coefficients Calculations

Capital structure coefficients

Indicators: Equity ratio and Gearing ratio

Indicator: Equity ratio or assets ratio (in Finnish, omavaraisuusaste)

The equity ratio indicates how much of the company's assets are financed by equity. It indicates the ratio of the equity to the total assets of the company. This indicator is also called as the company's financial independence ratio or solvency ratio and measures the amount of assets that are financed by owners’ equity shares. The calculations are based on the balance sheet data. Let's consider the Balance Sheet of the hypothetical company X.

The Equity ratio expresses as a percentage and calculates as following:

\[ {EQUITY\ RATIO} = {TOTAL\ EQUITY \over TOTAL\ ASSETS} * 100 \]
\[ {EQUITY\ RATIO} = {TOTAL\ EQUITY \over BALANCE\ SHEET\ TOTAL - ADVANCES\ RECEIVED} * 100 \]

In our example we have:

\[ {EQUITY\ RATIO} = {40+10+28 \over 117} * 100 = 66,7 \%\]

The lower the ratio result, the more loans and debts the company has and the higher the risk of insolvency. The low value of the coefficient also reflects the potential risk of an enterprise having a cash shortage. The indicative values according to the Yritystutkimusneuvottelukunta (YTN) for Equity ratio result interpretation are:

more than 40% Good
20 - 40% Satisfactory
less than 20% Weak

In our calculations we have got the Equity ratio equal to 66,7 %, that is an excellent result.

Indicator: Gearing ratio (in Finnish, nettovelkaantumisaste)

Gearing is the coefficient, the point of which is to determine the ratio of borrowed capital on which interest is accrued and total equity. It characterizes the intensity of borrowed funds usage and shows how many times are the loans exceed the company's capital. The calculations are based on the balance sheet data. Let's consider the Balance Sheet of the hypothetical company X.

The Gearing ratio expresses as a percentage and calculates as following:

\[ {GEARING\ RATIO } = {BORROWED\ CAPITAL - LIQUID\ ASSETS \over TOTAL\ EQUITY} * 100 \]

  • BORROWED CAPITAL - BORROWED CAPITAL on which interest is accrued
  • LIQUID ASSETS are assets that can be easily converted into cash and realized in a short period of time. Liquid assets include: money itself, gold, short-term government securities, funds on current accounts in banks, stocks, bonds, property that can be quickly sold and other assets which can be quickly sold without a serious loss in its value.
\[ {GEARING\ RATIO } = {20+7-10 \over 40+10+28} * 100 = 21,8\%\]

The lower the value of the ratio, the better the company's solvency.

In the capital-intensive industries or companies, the goal is to get the gearing ratio below 100%, whereas in non-capital-intensive industries this coefficient should be less than 30%. Capital-intensive industries are the manufacturing industries, such as automobile manufacturing, with a large share of capital in the asset structure, with the large amount of investments in production of goods. The large amount of liquid assets can lead to the negative value of indicator; however, the company's solvency can be excellent.

In our calculations we have got the Gearing ratio equal to 21,8 %, that is an excellent result.

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