The equity multiplier is a leverage ratio and is calculated by dividing total assets by total equity. It is also called financial leverage.
Equity multiplier formula:
Equity multiplier = Total assets / total equity
Actually, it is used to find out how much percentage of total assets has been financed by the shareholder’s equity. In simple words, it denotes the percentage of total assets owned by the shareholders. A low equity multiplier ratio is assumed to be the good one as the company has taken less debt to purchase the assets and as a result, it will not need to pay a higher portion of its cash flows & profit towards interest payments.
The equity multiplier is a financial ratio that demonstrates the proportion of debt and equity used to finance an investment. The higher this number, the more likely it is that the business will be able to pay back its debts with earnings. For example, if you have $100 in assets but $20 in liabilities, your equity multiplier would be 5x ($100 / $20 = 5). Most businesses operate at between 1-5x due to their need for liquidity (i.e., cash on hand) and flexibility (ability to raise capital when needed). High ratios are often seen as risky by lenders; however, they can also indicate that companies are leveraging themselves well financially.”
Total assets refer to the sum of all assets owned by an individual, company or organization. It can be used in net worth covenants and it’ll tell you how strong their financial position really is because after accounting for depreciation associated with those items we’re left with total equity (assets minus liabilities). Net worth on its simplest terms would equal total asset values plus any reserve funds set aside as protection against future economic uncertainty.
Shareholders equity is the difference between total assets and total liabilities. It’s also known as Shareholder capital, which can be broken down into two parts: shares issued by companies in exchange for money or products; these are called common stocks (or just “shares”), while preferred stock carries special privileges like dividend yield – this might seem risky but has been standard practice since inception so there must be something good behind why people do invest.
Example:
Alpha Plc has current assets amounting to $50,000, non-current assets amounting to $200,000. The total equity is $400,000.
Required: Calculate Equity multiplier.
Solution
Equity multiplier = Total assets / total equity = 50,000 + 200,000 / 400,000 = 250,000 / 400,000 = 62.5