Business Degree Certification Practice Test

What financial ratio shows the proportion of debt to equity in a business?

1. Current ratio

2. Debt-to-equity ratio

3. Gross margin ratio

4. Return on equity

The correct answer is: Debt-to-equity ratio

The debt-to-equity ratio is a crucial financial metric that measures the relative proportion of a company's debt to its shareholders' equity. This ratio is significant because it illustrates how much debt a company is using to finance its assets, highlighting the level of financial leverage. A high debt-to-equity ratio suggests that a business is relying more heavily on borrowed funds, which could indicate higher risk if the company faces financial difficulties. Conversely, a lower ratio implies that a company has funded a larger portion of its assets through equity, suggesting a potentially more stable financial structure. By analyzing this ratio, investors and analysts can assess the risk involved in a company’s capital structure and its ability to meet financial obligations. This makes the debt-to-equity ratio a pivotal tool in evaluating financial health and making investment decisions. Other financial ratios, such as the current ratio, gross margin ratio, and return on equity, serve different purposes and do not specifically address the relationship between debt and equity.