Identify the correct definition among leverage and coverage ratios: which statement correctly defines a standard financial ratio used in corporate analysis?

Difficulty: Easy

Debt ratio equals total debt divided by total assets.
Debt ratio equals total debt divided by shareholders' equity.
Debt-to-total assets ratio equals total equity divided by total assets.
Interest coverage ratio equals EBIT divided by interest expense for the period.
Both (a) and (d) are correct

Correct Answer: Both (a) and (d) are correct

Explanation:

Introduction / Context:
Precise definitions matter in ratio analysis; small wording errors can reverse a conclusion. Two of the most frequently referenced metrics are the debt ratio and the interest coverage ratio. This question asks you to identify which statements state standard textbook definitions correctly.

Given Data / Assumptions:

Total debt includes interest-bearing obligations (short and long term).
Total assets are from the balance sheet (usually average values for time-based analysis).
EBIT stands for earnings before interest and taxes.

Concept / Approach:
The debt ratio measures the share of assets financed by debt: Debt ratio = Total debt / Total assets. The interest coverage ratio measures a firm's ability to service interest from operating profit: Interest coverage = EBIT / Interest expense. Confusing the debt ratio with the debt-to-equity ratio is a common mistake, as is mislabeling equity/asset ratios.

Step-by-Step Solution:

Check (a): Matches standard definition of debt ratio.Check (b): This actually defines debt-to-equity, not debt ratio → incorrect.Check (c): Equity divided by assets would be the equity ratio, not debt-to-total assets → incorrect.Check (d): EBIT/Interest is indeed interest coverage → correct.

Verification / Alternative check:

Validate with a sample balance sheet and income statement—compute ratios and confirm names against a finance reference.

Why Other Options Are Wrong:

(b) confuses debt ratio with debt-to-equity; (c) confuses equity ratio with debt-based measure.

Common Pitfalls:

Using year-end instead of average balances for capital structure ratios; ignoring non-operating income when computing EBIT.

Final Answer:

Both (a) and (d) are correct

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Identify the correct definition among leverage and coverage ratios: which statement correctly defines a standard financial ratio used in corporate analysis?

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