What is Equity Multiplier
Equity multiplier is a financial ratio that measures the amount of the company’s assets that are financed by shareholders’ equity. The equity multiplier ratio is a comparison between the company’s total assets and the total shareholders’ equity to show how much the company uses its capital from the shareholders’ equity to buy assets.
The equity multiplier of 1.00 means the company financed (buy) all its assets by using its shareholders’ equity. Thus, the ratio of less than 1 indicates that the company using only the shareholders’ equity. In contrast, the ratio of more than 1 indicates that the company financed its assets by using both debt and equity.
A higher equity multiplier compared to the industry averages, historical equity multiplier, and the company’s rival indicates that the company is more likely to finance its assets with debt. In contrast, a lower equity multiplier indicates that the company is more likely to fund its assets with its shareholders’ equity.
Keep in mind, that there is no exactly perfect equity multiplier ratio, a good equity multiplier depends on the industry and the company’s historical performance. Too high an equity multiplier ratio may indicate that the company had a high debt burden. The too low ratio seems to be a good sign but sometimes it means the company is unable to borrow due to some issue.
Equity Multiplier Formula
The Equity Multiplier can be calculated by dividing the company’s total assets by the total equity, as the following equity multiplier formula:
- Equity multiplier = Total assets / Total equity
Optionally, the equity multiplier is also able to determine the company’s debt ratio by the following formula:
- Debt ratio = 1 – (1 / Equity multiplier)
For example, let’s say the Feriors company limited has the total assets of $200,000 and the total shareholders’ equity of $180,000 the equity multiplier will be: 200,000 / 170,000 = 1.18
And the Debt ratio will be: 1 – (1 / 1.18) = 0.15 or 15%
This means the company is financed its asset by using both debt and equity (the ratio is more than 1) and 15% of the company’s assets are financed by debt.
Frequently Asked Questions
The equity multiplier ratio is a comparison between the company’s total assets and the total shareholders’ equity to show how much the company uses its capital from the shareholders’ equity to buy assets.
The Equity Multiplier can be calculated by dividing the company’s total assets by the total equity as the following formula: EM ratio = Total assets / Total equity
A lower equity multiplier indicates that the company financed its assets with its shareholders’ equity. It seems to be a good sign but sometimes it means the company is unable to borrow due to some issue.
