All you need to know about equity multiplier
So, you want to know more about the equity multiplier and how it works. This is a simple formula and can be explained using a few words.
What Is the Equity Multiplier?
The equity multiplier represents a risk indicator that measures the portion of a company’s assets financed by stockholder’s equity rather than by debt.
How can we calculate the equity multiplier?
Equity multiplier formula
The equity multiplier formula is a financial ratio formula calculated by dividing its total assets by the total net stockholder’s equity. That means this formula measures that portion of the company assets financed by the stockholders’ equity. In brief, you can say that the equity multiplier helps us evaluate the company’s debt that is used to purchase assets.
How to Calculate Equity Multiplier?
To calculate the equity multiplier, it is necessary to divide the company’s total assets by the total net stockholder’s equity. Total net stockholder’s equity can be calculated as total assets minus total liabilities.
This formula is normally used in a company’s financial analysis to view the company’s financial condition. It will enable you to understand the exact amount of the company’s debt to buy assets. In the following formula, we will see how to find an equity multiplier:
Equity Multiplier = Total assets / Stockholder’s equity
So, the leverage multiplier formula shows that the equity multiplier is a financial leverage ratio.
Let we summarize:
How to find an equity multiplier?
To find an equity multiplier, you need to divide a company’s total asset value by its total shareholders’ equity. The equity multiplier risk indicator measures the portion of a company’s assets financed by stockholder’s equity rather than by debt.
Equity multiplier calculator
How does it help a company?
The success of a company mainly depends on investments in assets. Needless to say, a company cannot invest on its own by buying all those assets that can contribute to its future success. They rely on the debts for this purpose. This is not about a particular company or business only. Many businesses take obligations to invest in assets. Here the equity multiplier comes on. It enables a company to know its total assets and how much debt it has taken to buy assets. It will divide the company’s assets by the obligation to know the company’s exact financial status. The ratio is the indicator of the company’s financial condition and reveals the risk factor as well.
When the equity multiplier number is higher, it shows a risk factor. It reveals how the company relies on debts. Companies with more obligations will have to spend more on debt servicing that will affect their overall growth. They will have to get more profits and cash flows to ensure the smooth functioning of the company. Similarly, when the debt is less than expected, the company can expect more benefits. Equity multiplier helps a company evaluate its current financial conditions and find out all the possible ways to improve the situation and reduce the debt burden.
How does it work?
As stated earlier, it works very efficiently. The equity multiplier is a debt ratio. It divides the assets of a company with total debt. The result evaluates the current financial condition of a company. The low equity multiplier will be taken as a positive sign. A lower equity multiplier means the debt burden is more lacking. However, it has some negative impacts as well. It might indicate that the company is not considered trustworthy by investors to give debts, which affects the company’s overall performance. The reputation of the company will be affected when investors will not find it responsible for the investment.
Equity multiplier will help investors have a clear financial picture of a company, and the result can be effective in helping them decide on an investment. They can use the equity multiplier of different companies to know which one can offer more benefits. They can consider the following factors to make a decision.
A high equity multiplier means the company heavily depends on the debt, making investment risky. At the same time, high financial leverage ensures better market understanding, leading to more benefits.
The low equity multiplier indicates that the company has fewer debts, and the investment is predominantly conservative. It might create an impression that the growth possibility is limited to low financial leverage.
The perfect condition for investment is an ideal balance between debt and equity. 2:1 equity multiplier can influence investors to invest in that company.
An equity multiplier is a financial assessment ratio that clarifies a company’s current financial condition. It indicates both risk and profit factors depending on the outcome. Equity multiplier is used in the DuPont analysis for the economic assessment of a company.