What Is The Equity Multiplier Formula?
The equity multiplier formula is the equation that derives the ratio of total assets to total shareholders’ equity.The result is the financial leverage of a company that determines what portion of the stockholders’ equity a company has used to fund what amount of assets.
The equity multiplierEquity MultiplierThe equity multiplier is a simple ratio of total assets to total equity that helps us understand how much of the company's assets are financed by shareholder equity. If this ratio is higher, the financial leverage (total debt to equity) is higher and vice versa. compares the company’s total assets with the firm’s shareholders’ equity. The higher the value, the greater the company’s financial leverage. However, a lower ratio is appreciated as it indicates that a company is not obtaining debts to meet its asset requirements.
Table of contents
- The equity multiplier entails the proportion of the company’s assets financed through equity financing.
- The equity multiplier formula divides the total assets of the company by its total shareholders’ equity.
- If the equity multiplier is high, the company probably has very little debt, and its ownership is very heavily diluted. However, a low equity multiplier indicates that the corporation is heavily indebted, which increases risk.
- This multiplier helps investors determine the risk involved in an investment proposition in a company. It also helps investors plan the course of their investment and determine ownership prospects.
Equity Multiplier Formula Explained
Equity Multiplier Formula = Total Assets/Total Shareholders’ Equity
Let us discuss the two components to understand their effects on business finances.
- Total assets include both current assets and noncurrent assets. While the examples of current assetsExamples Of Current AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. Total assets include both current assets and noncurrent assets. While the examples of current assets are inventories, prepaid expenses, etc., the non-current assets examplesExamples Of Non-current AssetsNon-current assets are long-term assets bought to use in the business, and their benefits are likely to accrue for many years. These Assets reveal information about the company's investing activities and can be tangible or intangible. Examples include property, plant, equipment, land & building, bonds and stocks, patents, trademark. are building, machinery, plants, furniture, etc. The balance sheet of the company lists all these to help businesses calculate the total assets.
- The total shareholders’ equity is one of the most critical financial statements every investor should look at. It includes both common shares and preferred shares.
The ratio of the two helps investors assess the financial leverageFinancial LeverFinancial Leverage Ratio measures the impact of debt on the Company’s overall profitability. Moreover, high & low ratio implies high & low fixed business investment cost, respectively. of a company, allowing them to make better investment decisions.
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Example 1 (Manual)
Here’s a practical example to understand this formula better.
Tee Wear has the following information –
- Current Assets – $36,000
- Non-current Assets – $144,000
- Total Shareholders’ Equity – $540,000
Let us find out the equity multiplier of Tee Wear.
First, let us calculate the total assets.
- Total assets = (Current Assets + Non-current Assets) = ($36,000 + $144,000) = $180,000.
- Total shareholders’ equity is already given as $540,000.
Therefore, using the formula, the equity multiplier derived is –
- Equity multiplier = Total Assets / Total Shareholders’ Equity = $180,000 / $540,000 = 1/3 = 33.33%.
Depending on the industry standard, businesses can determine whether this ratio is higher or lower. Every investor needs to look at other companies in similar industries and glance at different financial ratiosFinancial RatiosFinancial ratios are indications of a company's financial performance. There are several forms of financial ratios that indicate the company's results, financial risks, and operational efficiency, such as the liquidity ratio, asset turnover ratio, operating profitability ratios, business risk ratios, financial risk ratio, stability ratios, and so on. to get a better idea of where each of them stands.
Example 2 (Excel)
Let us now consider the same example to check how to use the equity multiplier formula in Excel with the two inputs – Total Assets and Equity Multiplier. Here, the available details help calculate the equity multiplier ratio easily in the template provided.
Firstly, let us find out the total assets.
Now, let us calculate the equity multiplier.
Equity Multiplier – Godaddy vs. Facebook
- The above graph shows that Godaddy has a higher equity multiplier at 6.73x, whereas Facebook’s Equity Multiplier is lower at 1.09x.
- Therefore, it implies that Godaddy has more assets per unit equity and is over-dependent on debt to finance its assets. On the other hand, Facebook has a very Equity Multiplier (~1.09), it is independent of debt.
By using this multiplier, an investor is able to know whether a company invests more in debt or more in equity.
- If the equity multiplier ratio is higher, the company is too dependent on debt for its financing. In addition, it also means that investing in the company would be too risky for an investor.
- If the equity multiplier ratio is lower, the company is mainly sourced by equity, and debt financing is low. Moreover, it also indicates that the company doesn’t have much financial leverage to grow well shortly.
- The idea of finding out the equity multiplier is to balance both – debt and equity ratioDebt And Equity RatioThe debt to equity ratio is a representation of the company's capital structure that determines the proportion of external liabilities to the shareholders' equity. It helps the investors determine the organization's leverage position and risk level. . There’s no rule of thumb, but if a company has a debt-equity ratio of 2:1, it can be said that it’s maintaining a great balance between debt and equity.
It is difficult to know the real picture of the company by just looking at one ratio, and the same holds true for the equity multiplier ratio as well. Hence, it is recommended to investors also look at dividend-related ratios, profitability ratios, debt-equity ratios, and other financial ratios to have a holistic view of the company’s approach. Thus, tracing all ratios gives a solid base to make a prudent decision.
Equity Multiplier Calculator
Let us use an equity multiplier calculator to figure out this ratio:
|Equity Multiplier Formula =||
Frequently Asked Questions (FAQs)
The formula for calculating the equity multiplier is obtained by: Total Assets / Total Shareholders’ Equity.
The corporation probably has very little debt, and its ownership is greatly diluted if the equity multiplier is high. A low equity multiplier, on the other hand, suggests that the company is deeply indebted, which raises risk.
This multiplier aids investors in assessing the level of risk associated with a company’s investment opportunity. It also aids in determining ownership chances and the direction of an investor’s investment.
This article has been a guide to what is Equity Multiplier Formula. We explain with examples of how to calculate it manually and in Excel along with interpretations. You may also have a look at the articles below to learn more about Financial Analysis
- Multiplier FormulaMultiplier FormulaThe multiplier formula describes an effect that occurs as a result of increased investments (at the government or business levels), resulting in a proportional rise in the economy's overall income.
- Degree of Financial Leverage CalculationDegree Of Financial Leverage CalculationThe degree of financial leverage formula computes the change in net income caused by a change in the company's earnings before interest and taxes. It aids in determining how sensitive the company's profit is to changes in capital structure.
- Current Assets FormulaCurrent Assets FormulaThe formula for current assets is derived by adding all of the assets on the balance sheet that can be converted to cash in less than a year. Cash, cash equivalents, account receivables, inventories, marketable securities, prepaid expenses, and other current assets are the most common.
- Profitability Ratios FormulaProfitability Ratios FormulaProfitability ratios help in evaluating the ability of a company to generate income against the expenses. These ratios represent the financial viability of the company in various terms.