It determines the part of total assets financed using debt as well as equity. For example, suppose the equity multiplier calculator provides an answer equal to 3 times. In that case, this simply means that one part of the total asset is financed with the help of equity, and the remaining two-part are using debt.
There is no defined ideal equity multiplier that helps in understanding or indicating whether a company has a good equity base or is sufficiently funded with shareholders’ money or not. To check this, the management of the company should compare its equity multiplier with the industry-standard equity multiplier. Or, the company can also evaluate using its own past equity multipliers. Or can compare with a similar level company in the same industry.
More assets financed using debt is risky. If the company’s equity multiplier is constantly increasing from the past, it means the company is financing its assets using more of debt and less of equity.
The formula for calculating the equity multiplier is as follows:
Equity Multiplier = Total Assets / Common Shareholder’s Equity
How to Calculate using Calculator?
The equity multiplier calculator requires only the following two variables to be inserted.
Enter the amount of total assets of the business. This figure can be simply obtained from the balance sheet of the company. It is a total of either side of the balance sheet (total asset = equity + liability).
Common Shareholders’ Equity
It does not include the amount of preference share capital as preference capital has a fixed payment obligation attached to it. Common shareholders’ equity includes equity capital and reserve funds of the company. We can also call it Shareholders’ Kitty.
Consider the following data of two companies, X and Y, operating in the same sector.
|Total Assets ($)||300,000||110,000|
|Common Shareholder’s Equity ($) (incl reserves)||60,000||55,000|
The above calculation shows that company X uses more debt in financing assets than company Y. Company Y uses both equity and debt in equal proportions for financing its assets. While company X uses 20% equity and rest 80% debt.
As said above, there is no ideal equity multiplier for evaluating a company’s equity multiplier. The management should look for the industry-standard equity multiplier or its previous multipliers.
Assume that the equity multipliers of the last 3 years of both the companies are as follows:
Company Y has financed its assets by debt and equity in the same proportion in all three previous years and thus has a stable funding pattern over the years. While company X has fluctuating equity multipliers in the past. The fluctuations are also quite sharp instead of being a gradual one.