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.
Equity multiplier is a financial ratio formula that is calculated by dividing the total assets of the company 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 to evaluate the debt of the company that is used to purchase assets.
Do you want to know more about the equity multiplier and its usage? If yes, you can go through the following article. It will answer all your queries.
Equity multiplier formula
This formula is normally used in the financial analysis of a company to have a view of the company’s financial condition. It will enable you to understand the exact amount of the debt the company has taken to buy assets.
Equity Multiplier = Total assets / Stockholder’s equity
Equity multiplier calculator
How does it help a company?
The success of a company mostly depends on investments in assets. Needless to mention, a company cannot invest on its own on 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 debts 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 assets of the company by the debt to know the exact financial status of the company. The ratio is the indicator of the financial condition of the company 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 debts will have to spend more on the debt servicing that is going to 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 to evaluate its current financial conditions and find out all the possible ways to improve the condition and reduce the debt burden as well.
How does it work?
As stated earlier, it works very easily. 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. Lower equity multiplier means the debt burden is lower. However, it has some negative impacts as well. It might be the indication that the company is not considered trustworthy by investors to give debts and that affects the overall performance of the company. The reputation of the company will be affected when investors will not find it trustworthy for an investment.
Equity multiplier will help investors to have a clear financial picture of a company and the result can be effective to help them to 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 and that can make an investment risky. At the same time, high financial leverage ensures better market understanding and that might lead to more benefits.
The low equity multiplier indicates that the company has fewer debts and the investment is mostly 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.
Equity multiplier is a financial assessment ratio that gives a clear picture of 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 financial assessment of a company.