Solving the warnings (4/6): the equity ratio

The previous posts covered Financing, Net Income and Equity warnings. Let’s have a look at the equity ratio warning.

First, if you are unfamiliar with the equity ratio, you can learn more on it on the Accounting and Reporting Manual.

For as long as equity is positive, the equity ratio can take any value between 0 and 1. Zero means that a company has zero financing with equity and one means that the company is completely funded with equity. There is a threshold that is regarded as the minimum level for a good equity ratio and there are different opinions on what this “safety level” threshold should be. It should be noticed that this threshold is also related to the industry in which a company is at, because there are industries that are more dependent on external financing than others.

We, at CASFLOAPP, decided to set it at 0,2. Notice that a 0,2 equity ratio means that debt of a company is five times the size of its equity, thus meaning that the company is highly leveraged. Therefore, the equity ratio warning is triggered whenever the equity ratio is below 0,2. If you are looking for a different limit, then you should check equity ratio on the graphs or on the indicators report.

The equity ratio is only relevant if the equity warning is not triggered. If it is, you should first look into it and only then try to correct the equity ratio. The correction of the equity ratio warning takes the same steps as that of the equity warning. First look into the forecasts and then assess if more funding is necessary.

Remember that the warnings do not necessarily mean that something is wrong with your forecasting (except the financing warning), but that something might be wrong and needs attention. It will be up to you to decide whether action is needed or not.

The next post will be about solving the NPV warning. Stay tuned!