The equity ratio ( English equity ratio is) an economic indicator that the ratio of equity to total capital (= total assets ) of a company represents.
The equity ratio is the most important vertical balance sheet figure that provides information about a company's capital structure . It serves as the basis for financing decisions in the company itself. She is also interested in external competitors , credit institutions , other creditors , rating agencies and partners ( shareholders ). You have an interest in being able to measure your creditworthiness at any time. This requires transparency of the economic situation ( annual financial statements ) in order to be able to obtain information about the credit risk from these documents . In companies, equity and borrowed capital are brought into relation with one another, because the equity is available as a liability pool for the creditors and therefore the share of equity in the total capital is important. Consequently, the higher the equity ratio, the lower the creditor risk and vice versa.
As part of the annual financial statement analysis, the equity ratio is part of the financial analysis and, there, of the financing analysis. In the case of ratios such as the equity ratio, balance sheet items are compared, specifically the adjusted equity and the balance sheet total (total capital). To determine the equity ratio, it is first necessary to identify the balance sheet items belonging to equity. For this purpose, equity and debt positions are to be examined for their equity character and assets for their real asset character.
Differentiation from outside capital
The - not always easy - distinction between equity and debt capital is of major importance for analysts . If there is only the slightest possibility of repayment, the corresponding balance sheet item belongs to debt. Therefore, all types of provisions (including pension provisions ) form part of the debt, since there is at least a 50% repayment probability. A non-performance-related interest rate also speaks in favor of outside capital. Hybrid forms of equity are a hybrid between equity and debt capital and are therefore also called mezzanine capital :
- Subordinated loans ( English junior debt ): Are loans according to § 488 Paragraph 1 BGB and thus borrowed capital, the repayment of which is linked to the condition that they only have to be repaid after the satisfaction of other (senior) creditors ( senior debt ) . The condition is known as subordination designed subordination or subordination agreement and acts both in bankruptcy and in liquidation .
- Participation rights ( English participation rights ) are to blame legally established funds with shareholder typical property rights. In view of the large number of design options, it must be checked whether the issuer assumes an obligation to repay ( puttable instruments ) or whether the issuer only has a right of termination. A conditional repayment obligation only upon liquidation leads to the classification as equity, an unconditional one is to be shown as outside capital. In the case of credit institutions ( Section 10 (5) KWG) and insurance companies ( Section 214 (1), (2 ) and ( 4) VAG), profit participation rights can be recognized as regulatory equity if certain arrangements are made (see own funds (credit institution) ).
- Dormant companies ( English silent partnership ): These have under the legal concept more in the nature of a contractual obligation and are therefore to be considered in doubt as debt. In Section 231 (1) and Section 232 (2) HGB, loss sharing is provided, but it can be excluded (Section 231 (2) first half-sentence HGB). In the case of insolvency, the silent partner can assert his contribution that has not been consumed by losses as an insolvency creditor ( Section 236 (1) HGB).
- Hybrid bonds ( English hybrid bond ): These are bonds , an increase of debt, the first time usually tied after a period of 7 to 10 years by the issuer may be terminated ( issuer call options ). They usually have a subordinate clause for liquidation, dissolution and bankruptcy. There are hybrid bonds with very long maturities (between 30 and 100 years), even "eternal bonds" ( perpetuals ) are on the market.
- Shareholder loans ( english shareholder loans ): They are formally While borrowing, but they are treated as economic equity. Since November 2008, shareholder loans have been taken into account in the Insolvency Code (InsO) due to the law on the modernization of GmbH law and combating abuse (MoMiG) . All loan repayment claims by shareholders of a company without a natural person as a personally liable partner are classified as subordinated insolvency claims by law, regardless of their equity substitute character ( Section 39 (1) No. 5 and Sections 44a, 135 and 143 InsO).
International rating agencies recognize such hybrid forms of financing in whole or in part as economic equity if subordination is guaranteed. It is assumed that there must be a long term and / or a high share of losses and can therefore lead to recognition as equity.
Formal equity are the components listed in Section 266 (3) HGB under item A on the liabilities side of a balance sheet. These are:
- Subscribed capital : is the most important form of all equity components. It is the capital to which the liability of the shareholders for the liabilities of the corporation to the creditors is limited ( Section 272, Paragraph 1, Clause 1 of the German Commercial Code). Any outstanding capital, on the other hand, is not (yet) equity, because it represents a claim by the company on its shareholders, which must be shown separately on the assets side of the balance sheet before property, plant and equipment in accordance with Section 272 (1) HGB . Such a statement must be deducted from equity. However, offsetting the deposits with equity implies that the company's claims against the owners are worthless, i.e. H. would be irrecoverable, which in general should not be the case. This approach cannot be justified even for “reasons of caution”, because then considerable discounts would have to be made on all of the company's other assets.
- Capital reserve : is a legally required equity position and part of the open reserves .
Retained earnings : is the result of retained earnings .
- legal reserve:
- Reserve for shares in a controlling or majority-owned company
- statutory reserves
- other reserves
- Profit carryforward / loss carryforward
- Annual surplus / annual deficit.
Both nationally and internationally, companies are obliged to capitalize all asset items attributable to them . This capitalization requirement leads to an increase in equity, but does not mean that these asset items can also be viewed as equity for analysis purposes. In the business literature, the focus is on the following assets, some of which are highly controversial:
- Goodwill : According to the irrefutable presumption of Section 246, Paragraph 1, Clause 4 of the German Commercial Code, derivative goodwill is one of the assets that must be capitalized . It arose from the difference between a higher purchase price paid and the actual net worth of an acquired company or from corresponding consolidation processes. There are doubts whether it can ever be realized, so that it has to be deducted from equity.
- Claims on shareholders: Claims on shareholders outside of the outstanding capital must be deducted from equity (controversial).
- Own shares : The acquisition of own shares (limited to a few cases) ( Section 71 (1) AktG) has the effect of a capital reduction . Corresponding asset items are therefore to be deducted from equity.
- According to Section 4h (2c) sentence 5 EStG, 50% of the equity is allocated to special items with an equity portion, which can be used for analysis purposes.
Off-balance sheet assets and liabilities
The balance sheet total is increased if off-balance sheet financed assets are taken into account. This applies in particular to “leased” assets. Banks usually refrain from adjusting the balance sheet total for (unrecognized) leasing assets. Rating agencies , on the other hand, make extensive adjustments to the balance sheets (as well as the income statement ) to take into account leasing-financed assets.
The economic equity results from the following table:
Summe Eigenkapital im Jahresabschluss nach § 266 Abs. 3 HGB (Position A) + 50 % der Sonderposten mit Rücklageanteil - ausstehendes Kapital - Firmenwert + Gesellschafterdarlehen - sonstige Forderungen an Gesellschafter - sonstiges Mezzanine-Kapital - eigene Aktien = wirtschaftliches Eigenkapital
The economic equity determined in this way is taken into account in the equity ratio as follows:
The equity ratio thus reflects the relationship between economic equity and total assets.
The level of the equity ratio determined in this way has little informative value when viewed in isolation. Whether a company has adequate equity capital depends on criteria such as branch of industry , business purpose , company size and legal form .
Unique business principles to operating purpose and size of company could release standards for the capitalization of a company are not available. There are also no general rules about the ratio of equity to debt. It is generally recognized in economic literature that an upper limit for the degree of indebtedness can neither be theoretically justified nor derived empirically. Abstract normative provisions about the economically necessary equity capital or the correspondingly required general financial resources have not yet been shown.
“Adequate” equity is an indefinite legal term that relates a company's own funds to its total assets. In any case, in terms of tax law, equity is considered appropriate that is comparable with the capital structure of similar companies in the private sector in the relevant period. According to the 2004 corporate income tax guidelines, adequate equity capital is generally given "if the equity capital is at least 30% of the assets". With regard to the BFH jurisprudence, this 30% limit is primarily to be understood as a non-acceptance limit ; therefore, compliance with it is not objected to in external tax audits . For taxation purposes, the asset coverage ratio is assumed and the equity is classified as appropriate if the asset coverage ratio (I) is 30% and thus 70% of the fixed assets are to be financed by debt.
The optimal level of indebtedness is considered to be a ratio of equity to debt at which the average cost of capital is the lowest compared to other financing alternatives. A rule of thumb that comes from practice says that the level of indebtedness - depending on the sector - for non-banks should not be higher than 2: 1 (200%), i.e. the borrowed capital should not be more than twice the equity. Converted, the debt capital ratio must not be more than 67% of the balance sheet total, which results in a complementary equity ratio of 33%.
Equity ratio criteria
- “The average level of the equity ratio is highly industry-dependent. So have banks typically have a relatively low equity ratio of usually less than 10% ". In the case of plant-intensive manufacturing companies, however, the average equity ratio is relatively high.
- Company size : Large companies tend to have a higher equity ratio than small companies. The equity ratio and company size tend to correlate positively, because the smaller the companies examined, the lower the ratio.
- Legal form : Partnerships have relatively low equity ratios, since at least one person with full liability has unlimited liability with his / her private assets - which are not shown on the balance sheet. Corporations, on the other hand, have higher equity ratios, as they often belong to the investment-intensive sectors.
Special legal regulations
In Section 4h (2) (c) sentence 3 EStG , the equity ratio is defined as the ratio of equity to total assets within the framework of the interest barrier . There are also special regulations for credit institutions and insurance companies because these branches of the economy bear particularly high risks.
As part of the EU-wide capital adequacy regulation (English abbreviation CRR), the state banking regulation has stipulated statutory minimum ratios (especially with regard to so-called core capital ) that must be complied with in order to be able to conduct banking business properly . Own funds are the sum of core capital and supplementary capital (Art. 4 Para. 1 No. 118, Art. 72 CRR), eligible own funds are core capital (Art. 25 CRR) and supplementary capital according to Art. 4 Paragraph 1 No. 71 CRR (Art. 71 CRR) in the amount of a maximum of 1/3 of the core capital. The starting point is therefore the core capital, which according to Art. 25 CRR is made up of “common core capital” and “additional core capital”.
In life insurance, the equity ratio is a measure of the extent to which it can cover risks that arise from unpredictable developments in the capital market or mortality through equity . In private health insurance it is used to compensate for short-term losses. In this form, it approaches the legally stipulated equity ratio , the so-called solvency ratio (ratio between equity and premium income).
The equity ratio is an important indicator for the creditworthiness of a company, as it determines the rating . The rating agencies such as Standard & Poor’s take into account in their ratings the fact that a high level of debt ( debt to equity ratio ) also results in a high financial risk.
A high equity ratio means a low level of dependency on creditors and the associated low interest and repayment payments . This leads to favorable debt ratios such as the debt service coverage ratio . A correspondingly low debt ratio is usually accompanied by a low interest coverage ratio , because debts trigger interest and repayment payments that have to be financed from the sales process. A high level of indebtedness, on the other hand, increases the earnings risks because of the high debt servicing, because more profits are used for interest expenses and thus the break-even point rises with increasing debt ( cost leverage ). As a result, a low equity ratio creates employment risks .
A high equity ratio is associated with a high capacity to bear the losses incurred , so that such companies are less susceptible to crises and the risk of default for creditors is reduced. Companies with strong equity capital can absorb losses from their equity capital over a longer period of time and are more insolvent-proof than undercapitalized companies.
From the perspective of financial leverage , however, a low equity ratio leads to a high return on equity ( leverage effect ). This is one of the few positive effects of a low equity ratio. Because it can be a crisis indicator, since the "difficulties associated with a low equity ratio, such as bridging liquidity bottlenecks, obtaining bank loans and making necessary investments, significantly increase the risk [...] of getting into a crisis situation or even to be faced with bankruptcy ”.
- Jörg Baetge , Hans-Jürgen Kirsch , Stefan Thiele: Balance sheet analysis . 2nd Edition. IDW-Verlag GmbH, Düsseldorf 2004, ISBN 978-3-8021-1156-3 .
- Deutsche Bundesbank (Ed.) (2005a): "Earnings position and financing conditions of German companies - an investigation based on new data" , in October 2005 monthly report, pp. 33–71, 10/2005.
- Deutsche Bundesbank (Hrsg.) (2005b): " Ratios from the annual financial statements of German companies from 2002 to 2003" , Special Statistical Publication 6, 12/2005.
- Gleißner, W. (2003): "Light in the dark, status and development tendencies in bank ratings" (PDF; 51 kB), in Finance 11/2003, pp. 88–89, 2003.
- ↑ Andreas Hoerning, Hybrid Capital in the Annual Financial Statements , 2011, p. 26 ff.
- ↑ Ulrike L. Dürr, mezzanine capital in HGB and IFRS accounting , 2007, p. 264 ff.
- ↑ Andreas Hoerning, Hybrid Capital in the Annual Financial Statements , 2011, p. 57.
- ↑ Peter Seetaler / Markus Steitz, Praxishandbuch Treasury Management , 2007, p. 267 f.
- ↑ For the criticism of a blanket offsetting of the outstanding deposits with the equity, see Adolf G. Coenenberg , annual accounts and annual accounts analysis , 2005, p. 292 and the literature cited there.
- ↑ Michael Buschhüter / Andreas Striegel, International Accounting , 2009, p. 39 f.
- ↑ Steiner / Starbatty, The Importance of Ratings in Corporate Finance, in A.-K. Achleitner / O. Everling (Ed.), Handbuch Ratingpraxis, 2004, p. 29.
- ↑ Standard and Poor's Corporate Ratings Criteria ( Memento of the original dated July 2, 2013 in the Internet Archive ) Info: The archive link was inserted automatically and has not yet been checked. Please check the original and archive link according to the instructions and then remove this notice. , 2008, p. 69 ff. (PDF; 532 kB). The rating agencies use different methods to determine the amounts to be recognized for the leased assets. a. a factor approach in which all of the company's current rental payments are multiplied by a factor of 8. The “factor 8 approach” is also used by the rating agencies if the underlying assumptions (interest rate level, useful life) are not met, see ibid. For the analysis of the income statement , either the use of operating profit figures before consideration of rent payments ( rents ), "EBITDAR", is recommended, see p. 5, or a breakdown and reallocation of the rent payments into interest and depreciation components, see the key figure definitions at " Off-Balance Sheet Leases: Capitalization and Ratings Implications, Out of Sight but not Out of Mind ", Rating Methodology, Moody's Investors Service , Report # 48591, 10/1999 Metz / Cantor / Stumpp, The Effectiveness of Credit Ratings as Indicators of Relative Industry Default Risk , 2004, p. 30.
- ↑ Subordinated loans can be calculated with at least 50% of the economic equity
- ↑ Klaus Coss: Basic knowledge of financing: A practice-oriented introduction . Gabler, Wiesbaden 2006, ISBN 3-8349-0115-6 , pp. 59 .
- ^ Jan Wilhelm, Corporation Law , 2009, p. 188 f.
- ↑ Joachim Jickeli / Dieter Reuter, memorial for Jürgen Sonnenschein , 2003, p. 667.
- ↑ Alexander Bohn, interest rate limit and alternative models , 2009, p. 174.
- ↑ Karsten Schmidt , Corporate Law , 4th edition, § 9 IV 4 a, p. 240.
- ↑ BFH judgments of September 1, 1982 BStBl. 1983 II, p. 147 and of July 9, 2003 BStBl. 2004 II, p. 425.
- ↑ Corporate Income Tax Guidelines 2004, R 33 para. 2 sentence 3 KStR .
- ↑ Horst-Tilo Beyer, Finanzlexikon , 1971, p. 345
- ↑ Katharine Hoen, Key Figures and Balance Sheet Analysis , 2010, p. 11.
- ↑ Oliver Everling / Karl-Heinz Goedemeyer, bank rating: credit institutions on the test stand , 2004, p. 69.
- ↑ Michael Reuter, equity disclosure in the IFRS financial statements , 2008, p. 164.
- ^ Frank von Fürstenwerth / Alfons Weiss, Insurance Alphabet , 2001, p. 186.
- ^ Daniel Blum, Long-Term Corporate Success , 2008, p. 158.
- ↑ Belverd Needles / Marian Powers, Principles of Financial Accounting , 2013, p. 579.
- ↑ Jürgen Veser / Wolfgang Jaedicke, Equity in the construction industry , 2006, p. 62.