University of Central Florida (UCF) FIN3403 Business Finance Practice Exam 2

Evaluating a company's debt ratio primarily aims to determine how leveraged a company is, which refers to the extent to which it utilizes borrowed funds to finance its operations and growth. The debt ratio is calculated by dividing total liabilities by total assets, providing insights into the proportion of a company’s assets that are financed by debt. A higher debt ratio indicates more leverage, which can imply higher financial risk, as the company is more dependent on borrowed money. Conversely, a lower debt ratio suggests a more conservative approach with less reliance on debt.

Understanding a company's leverage is crucial for stakeholders, including investors and creditors, because it affects the company's risk profile and ability to meet its obligations. Leverage can amplify returns but also increases the risk of financial distress if the company faces downturns. Therefore, analyzing the debt ratio gives a clear indication of the company’s financial health and risk exposure related to its capital structure.