Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which formula depicts the debt to assets ratio?

1. Total Debt / Total Equity

2. Total Debt / Total Assets

3. Total Equity / Total Assets

4. Total Liabilities / Total Debts

The correct answer is: Total Debt / Total Assets

The debt to assets ratio is a financial metric that indicates the proportion of a company's assets that are financed through debt. This ratio is essential for assessing a company's leverage and financial risk, as it provides insight into how much of a company's assets are funded by debt rather than equity. The formula for calculating the debt to assets ratio is derived from the company’s balance sheet, where total debt represents all liabilities of the company, and total assets represent everything the company owns. By using the formula Total Debt / Total Assets, you are essentially measuring the extent to which the company's assets are leveraged by debt financing. A higher ratio indicates greater financial risk since it shows that a higher portion of the company's assets is financed through borrowing. In contrast, other formulas provided do not accurately represent the debt to assets ratio. For instance, total debt divided by total equity measures different aspects of a company's financial structure and risk, specifically focusing on the leverage of equity holders rather than the assets as a whole. The total equity to total assets ratio assesses the equity proportion of the financing structure, while total liabilities to total debts is an unclear expression that doesn’t directly reflect the standard definition of debt to assets. Therefore, the correct understanding of the debt to assets ratio is captured by the formula Total