How to Calculate Debt Ratio Using an Equity Multiplier
Original post by Bryan Keythman of Demand Media
An equity multiplier and a debt ratio are two financial metrics that measure a company's leverage, or the amount of debt a company uses to fund its assets. An equity multiplier compares total assets to total stockholders' equity, which is the money stockholders have invested in the company. The debt ratio compares total debt to total stockholders' equity. Higher numbers for each metric mean a company uses more debt to fund its business, which increases risk for stockholders. If you know a company's equity multiplier and the amount of its total assets, you can calculate its debt ratio.
Find the amount of a company's total assets on its most recent balance sheet. You can obtain a company's balance sheet in its most recent quarterly or annual report from the "investor relations" section of its website. For example, assume a company has $100,000 in total assets.
Divide total assets by the known equity multiplier to calculate total stockholders' equity. In this example, if a company's equity multiplier is 4, divide $100,000 by 4 to get $25,000 in total equity. An equity multiplier of 4 means the amount of the company's assets is four times the amount of its stockholders' equity.
Subtract total stockholders' equity from total assets to calculate the company's total liabilities, which is the same as total debt. In this example, subtract $25,000 from $100,000 to get $75,000 in total liabilities.
Divide total liabilities by total assets to calculate the debt ratio, which is also called the "debt to total assets" ratio. In this example, divide $75,000 by $100,000 to get 0.75, or a 75 percent debt ratio. This means a company is funding 75 percent of its assets with debt, which may suggest a higher amount of risk to stockholders.
Tips & Warnings
- Compare a company's debt ratio with the ratios of other companies in its industry to determine an acceptable level of debt. Different industries use varied levels of debt to fund their assets.
About the Author
Bryan Keythman has performed stock investment research and writing for a consulting firm since 2008. He also has prior experience sourcing and underwriting commercial real-estate investment and development opportunities for a commercial real-estate developer. Keythman holds a Bachelor of Science in finance.