Debt ratio

Question 1

what is the debt ratio?

Answer 1

The Debt Ratio assesses the extent to which a business relies on external finance to fund its assets.
It measures the portion of the business’s assets that are financed by liabilities.

Question 2

What are the dangers of a high debt ratio?

Answer 2

Indicates high reliance on liabilities, which increases the risk of financial collapse.
May result in the business being unable to meet loan repayments and interest charges.
Makes the business less attractive to lenders, limiting access to further borrowed funds.

Question 3

What is the benefits of a high debt ratio?

Answer 3

Allows the business to purchase assets it couldn’t otherwise afford.
These assets can generate revenue, which may increase business profit.
The business can grow using borrowed funds, not just the owner’s capital.

Question 4

what is return on owners investment (ROI) and how is it calculated?

Answer 4

ROI is a profitability indicator that measures how effectively a business uses the owner’s capital to earn profit.
It shows how many cents of profit are earned for every dollar invested by the owner.
Net profit/average capital x100

Question 5

Link Between Debt Ratio and ROI

Answer 5

A high debt ratio generally means higher risk, but also the potential for higher ROI.
This is because the business is earning profit using borrowed funds, not just the owner’s capital.
The owner still receives all the profit, even though their personal investment may be small.
If used wisely, external finance can boost returns, but mismanagement can lead to financial collapse.