Multiple Choice
Which ratio most directly indicates the extent of a company's reliance on financial leverage?
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14. Financial Statement Analysis
Ratios: Debt to Equity Ratio
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Join thousands of students who trust us to help them ace their exams!Watch the first videoMultiple Choice
When a company divides its total debt by its total equity, what financial ratio is it calculating?
A
Return on Equity
B
Gross Profit Margin
C
Debt to Equity Ratio
D
Current Ratio
Verified step by step guidance1
Identify the formula for the Debt to Equity Ratio, which is calculated as: \( \text{Debt to Equity Ratio} = \frac{\text{Total Debt}}{\text{Total Equity}} \).
Understand the components of the formula: 'Total Debt' refers to the sum of all liabilities (both short-term and long-term), and 'Total Equity' refers to the shareholders' equity as reported on the balance sheet.
Recognize that this ratio measures the proportion of a company's financing that comes from debt compared to equity, providing insight into the company's financial leverage.
Compare the given options: 'Return on Equity' measures profitability, 'Gross Profit Margin' measures profitability relative to revenue, and 'Current Ratio' measures liquidity. None of these involve dividing total debt by total equity.
Conclude that the correct financial ratio being calculated when dividing total debt by total equity is the 'Debt to Equity Ratio'.
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