21. _______ ratios measure the degree to which a firm relies on borrowed funds in its operations.
A. Retail earning
B. Wholesale earning
C. Earnings per share
D. Leverage (debt)
What do those terms mean?
The correct answer is D. Leverage (debt) ratios.
To understand how leverage (debt) ratios measure the degree to which a firm relies on borrowed funds in its operations, let's break it down.
Leverage ratios, also known as debt ratios, provide insights into a company’s use of debt to finance its operations. These ratios measure the proportion of a firm's capital that is financed by debt as opposed to equity.
To calculate leverage ratios, you would typically compare a company's total debt to its total assets or equity. Some commonly used leverage ratios include:
1. Debt-to-Asset Ratio: This ratio compares a company's total debt to its total assets. It indicates the percentage of a company's assets that are financed by debt. The formula for the debt-to-asset ratio is:
Debt-to-Asset Ratio = Total Debt / Total Assets
2. Debt-to-Equity Ratio: This ratio compares a company's total debt to its total equity. It shows the proportion of a firm's equity that is financed by debt. The formula for the debt-to-equity ratio is:
Debt-to-Equity Ratio = Total Debt / Total Equity
By analyzing these leverage ratios, investors, lenders, and analysts can gain insights into a company's financial risk and its ability to meet its debt obligations. A high degree of leverage can amplify both profits and losses, as interest payments on debt must be made regardless of a company's performance.