Which of the following ratios shows the relationship between a company's total debt and its net worth (equity)?

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

Answer: (A)

Verified step by step guidance

1. Step 1: Understand the concept of the Debt to Equity Ratio. This ratio measures the proportion of a company's total debt to its net worth (equity). It is a key indicator of financial leverage and risk.
2. Step 2: Recall the formula for the Debt to Equity Ratio: \( \text{Debt to Equity Ratio} = \frac{\text{Total Debt}}{\text{Total Equity}} \). This formula shows how much debt a company is using to finance its assets relative to the value of shareholders' equity.
3. Step 3: Compare the given options. The Gross Profit Margin measures profitability, Inventory Turnover Ratio assesses inventory management efficiency, and Current Ratio evaluates short-term liquidity. None of these relate to the relationship between debt and equity.
4. Step 4: Identify that the Debt to Equity Ratio is the correct answer because it directly shows the relationship between a company's total debt and its net worth (equity).
5. Step 5: Conclude that understanding this ratio is crucial for analyzing a company's financial structure and risk level, as higher ratios indicate greater reliance on debt financing.