The equity ratio — simply explained
What is the equity ratio? - The definition
Die Equity ratio is a business indicator that represents the ratio of equity to debt as a percentage. It measures a company's ability to self-finance and shows what percentage of the capital is covered by own funds. A high equity ratio signals financial stability and independence from outside capital providers, which in turn reduces credit risk and dependence on interest rate changes.
What is equity?
The equity ratio is calculated by dividing equity by total capital and multiplying the result by 100. Total capital is the sum of equity and debt capital.
instance: You buy a property privately for CHF 600,000 and finance 80% of it through your bank. Accordingly, debt capital amounts to CHF 480,000 and equity CHF 120,000, meaning that your equity ratio is CHF 120,000/480,000 x 100 = 20%.
How do you calculate the equity ratio?
The equity ratio is calculated by dividing equity by total capital and multiplying the result by 100. Total capital is the sum of equity and debt capital.
instance: If a company has an equity of 600,000 CHF and a total capital of 2,000,000 CHF, the result is an equity ratio of 30%. This means that 30% of the total capital is covered by own funds.
What does a high or low equity ratio mean?
A high equity ratio shows that a company is financially stable and less reliant on outside capital. Real estate portfolios with a high share of equity are better protected against market and interest rate changes, which improves credit ratings and lowers financing costs. However, a high equity ratio can lower the return on equity, as the profit is spread over more equity.
- High equity ratio: Offers financial stability and independence, but can reduce the return on equity, as profits are only attributable to equity.
- Low equity ratio: Increases debt risk and dependence on investors, but may result in a higher return on equity due to the leverage effect.
The optimal equity ratio depends on your risk appetite and market expectations.
Equity ratio in the real estate sector
The real estate market is very special in that the legislator prescribes clear requirements for the equity ratio and is therefore heavily interfering in the market.
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