## The debt ratio and the same multiplier room two balance sheet ratios the measure a company's indebtedness. Find out what lock mean and how to calculation them.

You are watching: The equity multiplier is equal to:

When you want to obtain an idea that a company"s financial condition, ratio analysis is among the devices of the trade. In the complying with article, you"ll learn about two beneficial balance sheet ratios: the debt ratio and the same multiplier, and also you"ll find out the relationship between the two and how to calculate one utilizing the other.

Companies finance your assets through two means: Debt and also equity. Let"s imagine firm A has assets totaling $300,000 that is has actually financed issuing $200,000 precious of debt and $100,000 of equity:

**Calculating the blame ratio**The debt ratio is the proportion of a company"s assets that is financed with debt:

Debt proportion = complete debt / total assets

The an ext debt the agency carries loved one to the dimension of its balance sheet, the greater the debt ratio. Total debt cannot be negative, nor have the right to it be greater than full assets (ignoring cases of an unfavorable equity), because of this the blame ratio have to be between 0% and 100% (the debt proportion is commonly expressed as a percentage).

In the case of firm A, us obtain:

Debt proportion = ( $200,000 / $300,000 ) = 2/3 ≈ 67%

Two-thirds of the agency A"s assets are financed with debt, through the remainder financed with equity.

**Calculating the same multiplier**The equity multiplier, top top the various other hand, relates the dimension of the balance sheet (i.e. Total assets) to the quantity of same ; in other words, it procedures the factor whereby the company"s equity has actually been leveraged:

Equity multiplier = full assets / complete equity

The higher the equity multiplier, the greater the lot of leverage.

For agency A, us obtain:

Equity multiplier = ( $300,000 / $100,000 ) = 3.0 times

**How to calculation the debt ratio using the equity multiplier (and vice-versa)**The debt ratio and the same multiplier are linked by the following formula:

Debt proportion = 1- ( 1 / equity multiplier )

Let"s verify the formula for agency A:

Debt ratio = 1-( 1 / 3 ) = 2 / 3 ≈ 67%, i m sorry is exactly the an outcome we discovered above.

If you want to know just how the formula linking the debt ratio was derived, it"s really straightforward utilizing some simple algebra. If you"re interested, girlfriend can discover the source at the bottom the the article.

**Examples: apple Inc. And Cheseapeake power Corporation**

Below is the appropriate balance sheet data taken right from **Apple Inc**"s most recent quarterly report:

Source: Apple, press release

Thus:

**Apple**

| $293,284/ $128,267 = 2.29 x |

| $165,017/ $293,284 = 56.3% |

Given the dimension of the operation cash flows Apple generates and the top quality of that is business, Apple"s usage of debt is conservative and also its equity multiplier reflect this.

Next, we have actually Chesapeake Energy"s condensed balance sheet, taken indigenous its many recent quarterly report:

Source: Chesapeake energy Corporation push releaseWe"re prepared to operation the numbers:

**Apple**

**Chesapeake Energy**

| 2.29 x | $17,357/ $$2,397 = 7.2 x |

| 56.3% | $14,960/ $17,357 = 86.2% |

Chesapeake power is no Apple! Its greater ratios reflect a very significant use that debt, and given Chesapeake Energy"s exposure to products prices, this is a an extremely different proposition in regards to the business" gaue won risk.

**Extra credit: Deriving the equation linking the debt ratio and also the equity multiplier**:

Equity multiplier = total assets / complete equity

Another method of writing that equation is:

Total equity / complete assets = ( 1 / same multiplier ) (1)

According come the fundamental equation of accounting:

Total same = full assets-Total debt

If we substitute that into equation (1), us obtain:

( full assets-Total blame ) / full assets = ( 1 / equity multiplier )

Which simplifies to:

1- ( total debt / full assets ) = ( 1 / equity multiplier )

Re-arranging the terms:

( total debt / complete assets ) = 1- ( 1 / equity multiplier )

But ( complete debt/ full assets ) is nothing various other than the debt ratio, so we have our result:

Debt proportion = 1- ( 1 / equity multiplier )

Voila!

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