Certified Financial Management Specialist Practice Exam

Which financial metric is calculated by dividing total liabilities by total equity?

1. Debt-to-equity (D/E) ratio

2. Return on equity (ROE)

3. Current ratio

4. Quick ratio

The correct answer is: Debt-to-equity (D/E) ratio

The financial metric calculated by dividing total liabilities by total equity is known as the debt-to-equity (D/E) ratio. This ratio provides insight into the financial leverage of a company, indicating the proportion of equity and debt used to finance the company’s assets. A higher ratio suggests that a larger portion of financing comes from debt, which can imply increased financial risk, while a lower ratio indicates greater reliance on equity financing, implicating a potentially more stable financial structure. In contrast, return on equity (ROE) measures a company's profitability by comparing net income to shareholders' equity. The current ratio assesses a company's ability to pay its short-term obligations with its current assets, and the quick ratio, also known as the acid-test ratio, is a more stringent measure that excludes inventory from current assets. Each of these metrics serves a different purpose and reflects distinct aspects of a company's financial health, unlike the D/E ratio, which specifically focuses on leveraging through debt and equity.