Future Business Leaders of America (FBLA) Agribusiness Practice Test

What does the debt-to-equity ratio indicate?

1. The extent to which debt capital is mixed with equity capital

2. The total amount of debt compared to total revenue

3. The relationship between short-term and long-term debt

4. The amount of equity available for reinvestment

The correct answer is: The extent to which debt capital is mixed with equity capital

The debt-to-equity ratio is a critical financial metric that reveals the proportion of debt and equity financing a company uses to support its operations and growth. When a company has a higher ratio, it indicates that it relies more on borrowed funds (debt) compared to equity provided by shareholders. This balance of using debt and equity is vital for understanding the financial structure and risk profile of a business. A higher ratio may suggest that a company could be at greater financial risk, as it needs to service its debt regardless of its financial performance. Conversely, a lower ratio may indicate a more conservative financial approach, suggesting less reliance on borrowing. The other options do not accurately capture the essence of what the debt-to-equity ratio represents. Understanding this ratio helps stakeholders, including investors and creditors, gauge how well a company can manage its obligations and how it finances its growth strategy.