Let’s compare Apple to Verizon Communications (VZ), which has a different business model. The company’s total assets were $366.6 billion for the fiscal year 2021, with $83.2 billion of shareholders’ equity. The equity multiplier for Verizon was 4.41x (366.6 ÷ 83.2) based on these values. Consider Apple’s (AAPL) balance sheet at the end of the 2021 fiscal year. The company’s total assets were $351 billion, and the book value of shareholders’ equity was $63 billion. A lower equity multiplier indicates that the company financed its assets with its shareholders’ equity.

Using the equity multiplier formula to assess your business debt, risk, and overall health

This is because a greater portion of ABC Company’s financing comes from debt, which must be repaid with interest. If ABC Company is unable to generate enough revenue to cover its interest payments, it may default on its debt obligations. This means that for every $1 of equity, the company has $1.50 of debt.

• The equity multiplier for Verizon was 4.41x (366.6 ÷ 83.2) based on these values.
• Companies can manage their equity multiplier by carefully controlling the level of debt they take on relative to their equity.
• The formula for calculating the equity multiplier consists of dividing a company’s total asset balance by its total shareholders’ equity.
• Let us discuss the two components to understand their effects on business finances.

Why should an investor depend on DuPont analysis after looking through multiplier?

For instance, if a company has an equity multiplier of 2x, the takeaway is that financing is split equally between equity and debt. Let us try to understand the concept of equity multiplier calculation with the help of some suitable examples. ABC Company is more leveraged than XYZ Company, and therefore has a higher level of risk.

It’s evident that ABC Company is the least appealing of the two companies. Equity multiplier can also compare the financial leverage of different companies. Businesses with a higher equity multiplier generally are more leveraged. Low equity multiplier is a low risk indicator, since the company is more reliant on equity financing. Equity multiplier can also compare the financial structure of different companies.

When a company’s equity multiplier is low, it shows that a company a generally financed by stockholders, so debt financing is low and the investment is fairly conservative. This may seem to be positive, but its downside is the company will have low growth prospects and therefore low financial leverage. Many companies invest in assets to support day-to-day operations and fuel growth. To pay for these assets, they can use debt, equity, or a combination of both. However, the balance of these sources of finance on a company’s books affect its overall health, so investors and creditors need a quick way to measure and compare it.

Equity multiplier is a leverage ratio that measures the portion of the company’s assets that are financed by equity. It is calculated by dividing the company’s total assets by the total shareholder equity. The equity multiplier measures the ratio equity multiplier formula of total assets to total equity, while the debt-to-equity ratio compares a company’s total debt to its total equity.

Comparing the Equity Multiplier with Other Financial Ratios

In the model, return on equity (ROE) is split up into its common financial ratio and metric components, namely, net profit margin, asset turnover and the equity multiplier. An equity multiplier of 1.11 indicates that Harlitz has very low debt levels. Specifically, a mere 10% of his assets are debt-funded and the remaining 90% is financed by investors.

Best Practices for Using the Equity Multiplier in Financial Analysis

The financial analysts, investors and management use this metric of equity multiplier ratio to evaluate the risk profile of the business. If the company is already doing well and is profitable, then leverage will provide benefit in the form of funds for further expansion. But during downturns, if the company is having a good customer base and has the history of consistent devidnd payment, it is a good idea to raise funds through equity. Within the DuPont framework, the equity multiplier amplifies the effects of profit margin and asset turnover. A company with strong earnings and efficient asset use can achieve high ROE with appropriate leverage. However, excessive leverage, marked by a high equity multiplier, increases risk and may lead to financial instability during economic downturns.

However, both of them focus of different aspects and have different conclusions. On the other hand, Verizon’s multiplier risk is high, meaning that it is heavily dependent on debt financing and other liabilities. The company’s proportion of equity is low, and therefore, depends mainly on debt to finance its operations.

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. Thus, tracing all ratios gives a solid base to make a prudent decision. 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. That’s why you need to go to the advanced calculation and look at the financial leverage ratios in detail. Both the debt ratio and equity multiplier are used to measure a company’s level of debt.

Pfizer’s equity multiplier ratio of 3.21x is similar to Walmart’s, indicating a moderate level of financial leverage. As a pharmaceutical company, Pfizer operates in a capital-intensive industry that requires significant investments in research and development, manufacturing, and marketing. The company’s financial strategy aims to balance debt and equity financing to support its growth initiatives while maintaining financial stability. The equity multiplier is a critical indicator of a company’s financial structure.

Why is equity multiplier important for investors?

This is because it is calculated by dividing total assets with total equity. Since both total assets and total equity are positive numbers, equity multiplier will always be a positive number. Total equity is on a company’s balance sheet or in its shareholder’s equity section. No, the appropriate level of the equity multiplier varies by industry.

• If the ratio is high, it would signify that the proportion of debt is higher as compared to equity and a lower ratio would indicate a higher proportion of equity.
• The financial analysts, investors and management use this metric of equity multiplier ratio to evaluate the risk profile of the business.
• By adjusting the equity multiplier, analysts can simulate how changes in financial leverage might impact the company’s profitability, cash flow, and risk profile.
• It helps stakeholders understand how a company is financing its operations and growth.
• Assets are greater than the equity, and therefore liabilities must have been used to fund the business.

This means that for every $1 of equity, Company XYZ has $2 of debt ratio or other liabilities. This equation shows that a higher equity multiplier, through increased financial leverage, can significantly boost ROE, assuming profit margins and asset turnover remain constant. 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. The equity multiplier ratio formula is the assets divided by the equity of the business. The equity multiplier is important for investors because it offers a glimpse of a company’s capital structure and how much debt the company has.

And if the ratio turns out to be lower, the financial leverage is lower. At its core, the equity multiplier is a financial leverage ratio that measures the proportion of a company’s assets that are financed by its shareholders’ equity. It reflects how much of a company’s assets are financed by equity versus debt. The higher the equity multiplier, the more debt a company has used to finance its assets, indicating higher financial leverage. When a firm is primarily funded using debt, it is considered highly leveraged, and therefore investors and creditors may be reluctant to advance further financing to the company.