What does the debt-to-equity ratio measure in a company?

The debt-to-equity ratio is a critical financial metric that measures a company's financial leverage and risk. It is calculated by dividing the company’s total liabilities by its shareholders' equity. This ratio provides insight into how much debt the company is using to finance its operations relative to the equity provided by its shareholders.

A higher debt-to-equity ratio indicates that a company is relying more on borrowed funds to finance its growth, which can be a double-edged sword. While leveraging can increase returns on equity during good times by amplifying profits, it also increases the financial risk during downturns since the company is obligated to repay its debts regardless of its profit situation. Conversely, a lower ratio suggests that a company is more conservatively financed, potentially indicating stability and reduced risk.

Understanding this ratio helps investors and analysts assess the risk associated with a company’s capital structure, including its ability to meet its financial obligations and potential exposure to financial distress. Thus, the debt-to-equity ratio is primarily a measure of financial leverage and risk, making the chosen answer accurate and relevant in the context of evaluating a company’s financial health.