Which ratio best indicates long-term financial risk from debt relative to owner's funds?

Which ratio best indicates long-term financial risk from debt relative to owner's funds?

• A. Current ratio
• B. Debt to equity ratio
• C. Net profit margin
• D. Gross profit percentage

Answer: (B)

Understanding leverage: how much debt a business uses compared with the owners’ funds. The debt-to-equity ratio directly compares what the company owes (liabilities) to what the owners have invested (owners’ equity), so it shows financial leverage. A higher ratio signals more debt relative to equity, meaning greater long‑term risk because debt service reduces_cash flow and losses can erode equity faster. This makes it the best gauge of long‑term risk from debt versus owner’s funds. The current ratio measures short‑term liquidity, not long‑term solvency, while profit margins reflect profitability rather than leverage.

Understanding leverage: how much debt a business uses compared with the owners’ funds. The debt-to-equity ratio directly compares what the company owes (liabilities) to what the owners have invested (owners’ equity), so it shows financial leverage. A higher ratio signals more debt relative to equity, meaning greater long‑term risk because debt service reduces_cash flow and losses can erode equity faster. This makes it the best gauge of long‑term risk from debt versus owner’s funds. The current ratio measures short‑term liquidity, not long‑term solvency, while profit margins reflect profitability rather than leverage.