Funeral Arts National Board Practice Exam

What gauge represents a business's financial leverage by dividing total liabilities by stockholders' equity?

1. Current ratio

2. Debt equity

3. Return on equity

4. Profit margin

The correct answer is: Debt equity

The representation of a business's financial leverage through the division of total liabilities by stockholders' equity is known as the debt-to-equity ratio. This financial metric indicates the extent to which a company is using borrowed money to finance its operations compared to what shareholders have invested. A higher debt-to-equity ratio signifies greater financial leverage, implying that a company relies more on debt to fuel growth and operations, which can increase the potential return for equity holders but also comes with enhanced risk. Other financial ratios listed, such as the current ratio, return on equity, and profit margin, serve different purposes. The current ratio focuses on a company's ability to meet short-term obligations, return on equity measures profitability relative to shareholders' equity, and profit margin assesses how much profit a company makes for every dollar of revenue generated. Each of these ratios provides valuable insight into various aspects of a company's performance, but they do not specifically highlight financial leverage in the same manner as the debt-to-equity ratio does.