What is the Equity Multiplier?

The DuPont model breaks the return on equity (ROE) calculation into three ratios; asset turnover ratio, net profit margin, and equity multiplier. There are two components that need to be discussed in the equity multiplier formula, these are the total assets and the shareholders’ equity. HP Inc’s balance sheet for 2020 states that total assets were $34,681, and its total shareholder equity was worth $2,228. Inputting these values into the EM equation provides HP with a leverage ratio of 15.56. It is essential to determine if a company relies on debt to finance its assets or if it utilizes shareholders’ equity.

• It calculates a company’s assets by funded stockholder’s equity rather than by just comparing it by debts.
• No matter what the equity multiplier tells us, I don’t think we can ever know for sure if a business is going to be successful or not.
• If a company has an equity multiplier of 2, this means that a company is equally financed by debt and stockholder equity.
• Equity Multiplier Formula is a division of the Total Assets and Total shareholder’s Net Equity of a company.

Lower equity multipliers are likely better for investors, but this varies between industries and companies with particular industries. If a company’s equity multiplier is greater than the average for its industry and in relation to its peers, this indicates that the company is using more debt to finance its assets. https://www.bookstime.com/ You can use the “equity multiplier formula” or “equity multiplier ratio” to calculate a company’s debt ratio. A financial leverage ratio that measures the portion of assets financed. In contrast, a lower equity multiplier indicates that the company is more likely to fund its assets with its shareholders’ equity.

Calculating the Debt Ratio Using the Equity Multiplier

Consider Apple’s (AAPL) balance sheet as we look at the close of this financial year 2020. The company’s having total assets were $338.5 billion, and with a book value of shareholder equity was $90.5 billion. The company’s equity multiplier ratio was so 3.74 ($338.5 billion / $90.5 billion). It is a bit higher than was an equity multiplier for 2019, which was 3.41.

The equity multiplier is a financial leverage ratio that measures a company’s financial structure and the amount of the company’s assets that are financed by equity. It is calculated by dividing a company’s total assets by its total equity. Equity multiplier is a financial ratio that measures the amount of the company’s assets that are financed by shareholders’ equity.

Fixed Asset Turnover Ratio Definition and Formula

In some cases, for instance, a low equity multiplier could indicate that the company cannot find willing lenders; or it could also signal that a company’s growth prospects are low. On the other hand, a high equity multiplier is not always a sure sign of risk. High leverage can be part of an effective growth strategy, https://www.bookstime.com/articles/equity-multiplier especially if the company is able to borrow more cheaply than its cost of equity. From the above example, the Conclusion is Shareholder funds, not the bank or financial institution debt, drive a company’s growth. The equity multiplier can reveal a lot about a business and what level of risk it may pose to investors.

• A low multiplier may suggest a company is struggling to secure funding from a lender on reasonable terms.
• This is because Honda is believed to already have large debts and high debt service charges.
• The company’s equity multiplier is therefore $1,000,000 divided by $200,000 equalling 5.
• Companies who are having a higher debt burden will have huge debt servicing type of costs.
• Second, if the ratio is high, the assumption is that a large amount of debt is being used to fund payables.

Conversely, if the ratio is low, it implies that management is either avoiding the use of debt or the company is unable to obtain debt from prospective lenders. A lower equity multiplier indicates a company has lower financial leverage. In general, it is better to have a low equity multiplier because that means a company is not incurring excessive debt to finance its assets. Instead, the company issues stock to finance the purchase of assets it needs to operate its business and improve its cash flows.

It provides a useful metric of overall financial health for investors or creditors

In the final step, we will input these figures into our formula from earlier, which divides the average total assets by the total shareholder’s equity. First, if an organization uses accelerated depreciation, since doing so artificially reduces the amount of total assets used in the numerator. Second, if the ratio is high, the assumption is that a large amount of debt is being used to fund payables. However, the organization may instead be delaying the payment of its accounts payable in order to fund the assets.

With interest rates at record lows since the 2008 financial crisis, Apple has taken the opportunity to access cheap funding on several occasions over the last few years. It can justify borrowing because its revenues grew by an average of just over 11% a year between 2018 and 2021, much higher than the interest rate charged by lenders. So, if you weren’t too fond of math when you were in school, get ready for it because you’ll need it. Would you like to find out more about the equity multiplier and the way it works?