What does the debt-to-equity ratio measure and how is it calculated?

What does the debt-to-equity ratio measure and how is it calculated?

• A. Measures profitability; Debt-to-Equity = Net Income / Total Equity.
• B. Measures financial leverage; Debt-to-Equity = Total Liabilities / Total Equity.
• C. Measures liquidity; Debt-to-Equity = Current Assets / Current Liabilities.
• D. Measures asset efficiency; Debt-to-Equity = Total Assets / Total Equity.

Answer: (B)

The debt-to-equity ratio measures financial leverage, showing how much debt a company uses to finance its assets relative to shareholders’ equity. It is calculated by dividing total liabilities by total equity (Total Liabilities / Total Equity). A higher ratio indicates more leverage and higher financial risk, while a lower ratio suggests the company relies less on debt. The other choices mix different concepts: profitability uses net income relative to equity, liquidity uses current assets relative to current liabilities, and using total assets relative to equity isn’t the standard debt-to-equity measure.

The debt-to-equity ratio measures financial leverage, showing how much debt a company uses to finance its assets relative to shareholders’ equity. It is calculated by dividing total liabilities by total equity (Total Liabilities / Total Equity). A higher ratio indicates more leverage and higher financial risk, while a lower ratio suggests the company relies less on debt. The other choices mix different concepts: profitability uses net income relative to equity, liquidity uses current assets relative to current liabilities, and using total assets relative to equity isn’t the standard debt-to-equity measure.