Which of the following statements about debt management ratios is incorrect?

• A. The debt ratio is a capitalization ratio, while the debt-to-equity ratio is a coverage ratio.
• B. The debt ratio measures financial risk.
• C. The debt-to-equity ratio indicates leverage per unit of equity.
• D. The debt ratio is calculated as total debt divided by total assets.

Answer: (A)

Debt management ratios reveal how debt relates to assets and equity and to the firm’s ability to meet obligations. The statement that the debt ratio is a capitalization ratio, while the debt-to-equity ratio is a coverage ratio, is not correct. The debt ratio is a leverage or solvency measure, calculated as total debt divided by total assets, showing what portion of assets is funded by debt and signaling financial risk as that burden increases. The debt-to-equity ratio is also a leverage measure, indicating leverage per unit of equity, calculated as total debt divided by total equity. Coverage ratios, which include measures like times interest earned or debt service coverage, assess the ability to meet fixed charges, not the proportion of assets financed by debt. The other statements align with standard definitions: the debt ratio does relate to financial risk, the debt-to-equity ratio indicates leverage per unit of equity, and the debt ratio equals total debt divided by total assets.