Fundamentals Of Accountancy, Business, And Management (FABM) 2 Practice Exam

Which formula defines debt-to-equity ratio?

Debt-to-Equity = Total Liabilities / Total Equity Debt-to-Equity = Current Liabilities / Current Assets Debt-to-Equity = Total Equity / Total Liabilities Debt-to-Equity = Net Income / Total Equity

Correct Answer:

Debt-to-Equity = Total Liabilities / Total Equity

Explanation:

The debt-to-equity ratio tells you how much debt a company relies on relative to its shareholders’ equity. It is calculated by dividing total liabilities by total equity. This shows leverage—how much funding comes from creditors versus owners. A higher ratio means more debt per unit of equity, signaling greater financial risk if earnings drop, while a lower ratio indicates more equity funding and potentially less risk. The other formulas don’t capture leverage properly: using current liabilities over current assets measures short-term liquidity, not overall leverage; equity over liabilities is the inverse of the debt-to-equity ratio; and net income over equity reflects profitability, not how much debt is used relative to equity.

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