The asset-to-equity ratio (also known as the equity multiplier) gives a sense of how much of the total assets of a company are really owned by shareholders as compared to those that are financed by debt. Some businesses thrive more on borrowing money than other companies.
High assets-to-equity may be good for them. However, there is always some point for any company at which their assets are over-leveraged. That can be dangerous to the shareholders and their investment in the company (e.g., Lehman Brothers was so over-leveraged in 2007 that their asset-to-equity was 31! Calls on their debt in 2008 more than wiped out the company, resulting in global crisis).
Debt financing typically offers a lower rate compared to equity. However, too much debt financing is rarely the optimal structure because debt has to be paid back even when the company is going through troubled times.
Formula for Asset to Equity Ratio
\(Asset\,to\,equity = \frac{{Total\,assest}}{{Shareholder\,equity}}\)
Example
Anil Company has total assets in the amount of Rs.13,20,000 and shareholder equity in the amount of Rs.5,20,700. This gives an asset-to-equity ratio of 2.54. Thus, the business has about Rs.2.54 of assets for every rupee of shareholder equity.
