Chartered Financial Analyst (CFA) Level 1 Practice Exam

How is the debt-to-assets ratio defined?

1. Total liabilities / Total assets

2. Total debt / Total assets

3. Total equity / Total debt

4. Total debt / Total liabilities

The correct answer is: Total debt / Total assets

The debt-to-assets ratio is defined specifically as the total debt of a company divided by its total assets. This ratio provides insight into the extent to which a company's assets are financed by debt, helping assess financial leverage and risk. A higher debt-to-assets ratio indicates that a large portion of the company’s assets is funded by debt, which may imply increased financial risk if those debts are not managed effectively. Total debt includes both short-term and long-term liabilities, which gives a more comprehensive picture of a company’s obligations relative to the resources it has available (its total assets). This distinction is crucial because using the entire debt figure alongside total assets can better illustrate the dependency on borrowed funds in financing the company's operations and investments. The other options relate to different calculations or concepts that do not accurately reflect the definition of the debt-to-assets ratio. For example, dividing total liabilities by total assets focuses on all liabilities rather than just the debts, while the ratio of total equity to total debt measures a different aspect of financial health.