Which of the following ratios includes a component to evaluate financial leverage?

• A. Debt to Equity Ratio
• B. Inventory Turnover Ratio
• C. Current Ratio
• D. Gross Profit Margin

Answer: (A)

Verified step by step guidance

1. Understand the concept of financial leverage: Financial leverage refers to the use of debt to acquire assets, with the goal of increasing returns to equity holders. Ratios that evaluate financial leverage typically involve debt and equity components.
2. Analyze the Debt to Equity Ratio: This ratio measures the proportion of debt financing relative to equity financing. It is calculated as \( \text{Debt to Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Total Equity}} \). This directly evaluates financial leverage.
3. Review the Inventory Turnover Ratio: This ratio measures how efficiently a company manages its inventory. It is calculated as \( \text{Inventory Turnover Ratio} = \frac{\text{Cost of Goods Sold}}{\text{Average Inventory}} \). It does not involve debt or equity and is unrelated to financial leverage.
4. Examine the Current Ratio: This ratio assesses a company's short-term liquidity by comparing current assets to current liabilities. It is calculated as \( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \). It does not evaluate financial leverage.
5. Consider the Gross Profit Margin: This ratio measures profitability by comparing gross profit to revenue. It is calculated as \( \text{Gross Profit Margin} = \frac{\text{Gross Profit}}{\text{Revenue}} \). It does not include components related to debt or equity and is unrelated to financial leverage.