If business operations are good, the company’s financial leverage will also be good. It’s calculated by dividing a firm’s total assets with total equity. On the other hand, company DEF, which is in the same sector as company ABC, has total assets of $20 million and stockholders’ equity of $10 million. This means company DEF uses equity to finance 50% of its assets and the remaining half is financed by debt. Suppose company ABC has total assets of $10 million and stockholders’ equity of $2 million. This means company ABC uses equity to finance 20% of its assets and the remaining 80% is financed by debt.

- This is because revenue will need to increase to satisfy increasing debt service charges.
- On the other hand, company DEF, which is in the same sector as company ABC, has total assets of $20 million and stockholders’ equity of $10 million.
- Austin has a Bachelor of Science in Engineering and a Masters of Business Administration in Strategy, Management and Organization, both from the University of Michigan.
- If you have access to your company’s annual financial reports, you will be easily able to find the total asset value and shareholders’ equity amount in them.
- The equity multiplier is a commonly used financial ratio calculated by dividing a company’s total asset value by total net equity.
- Since both total assets and total equity are positive numbers, equity multiplier will always be a positive number.

## Equity Multiple

Tom’s return on equity will be negatively affected by his low ratio, however. Equity multiples and other financial ratios are great tools to take a quick look into a company. These ratios are not encompassing a company’s health and capital structure, though. The EM ratio can be found either in a completed form or by inputting the formula with a company’s given financial data.

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An equity multiplier is a financial leverage ratio that measures the portion of assets financed by shareholders within a company. It can be found from the total value of a company’s equity divided by the total value of shareholders’ the equity multiplier is equal to equity. The equity multiplier is a financial ratio that measures how much of a company’s assets are financed through stockholders’ equity and is calculated by dividing total assets by shareholders’ equity.

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A lower equity multiplier is preferred because it indicates the company is taking on less debt to buy assets. In this case, company DEF is preferred to company ABC because it does not owe as much money and therefore carries less risk. When a firm’s assets are primarily funded by debt, the firm is considered to be highly leveraged and more risky for investors and creditors.

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If the equity multiplier fluctuates, it can significantly affect ROE. Higher financial leverage drives ROE upward, all other factors remaining equal. The values for the total assets and the shareholder’s equity are available on the balance sheet and can be calculated by anyone with access to the company’s annual financial reports.

Companies that rely too heavily on debt financing will have high debt service costs and will have to raise more cash flows in order to pay for their operations and obligations. Calculation of the equity multiplier is relatively simple and straightforward. Consider the balance sheet of Apple Inc. (AAPL) as of the end of fiscal year 2017. The company’s https://www.bookstime.com/articles/accounting-for-plumbers total assets were $375 billion, and the book value of shareholder equity was $134 billion. The company’s equity multiplier was therefore 2.8x, which can be compared with its equity multiplier for the year 2016, which was 2.34x. Verizon Communications Inc. (VZ) operates with a very different business model that includes more financial leverage.

- If ROE changes over time or diverges from normal levels for the peer group, the DuPont analysis can indicate how much of this is attributable to the use of financial leverage.
- However, there is bound to be a certain debt component; when that happens, the equity multiplier ratio rises up.
- In some cases, it could mean the company is unable to find lenders willing to loan it money.
- This will decrease the denominator of the equation, while keeping the numerator (debt) constant.
- More reliance on debt financing results in higher credit risk – all else being equal.
- After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.

Let’s calculate a company’s equity multiplier by using a fictional example to get a better sense of the financial concept. For companies to acquire assets and conduct business, they will need to either finance their activities by injecting their own equity, issuing debt, or any possible combination of the two. This is not a problem while the interest rate environment is benign, but it’s a risky strategy when conditions change. As such, keeping an eye on the equity multiplier in the context of how a company generates earnings is a good idea. The table below shows a very impressive increase in ROE over the 2013 through 2022 period.

This data can be found easily from a simple search or the company’s financial reports (declared in quarterly or annual results). So it is safe to assume that Verizon’s cash flows may be more strained than Apple’s solely because of their high debt levels. However, one must note that high debt levels are not necessarily harmful. The formula to compute the equity multiple requires only two inputs. Therefore, relying solely on the equity multiple to guide investment decisions can be costly.