DECA Financial Consulting Complete Practice Exam

A high debt-to-equity ratio typically indicates a higher degree of financial risk because it means that a company is using more debt relative to its equity to finance its operations. When a company borrows a significant amount of money, it increases its leverage, which can amplify both returns and risks. If the company is successful and generates sufficient profits, the use of debt can enhance returns to equity holders. However, in times of financial downturn or operational difficulties, the obligations to repay debt remain, potentially leading to financial distress or bankruptcy.

This financial metric signals to investors and analysts that the company may face challenges during economic fluctuations because it has a larger proportion of debt obligations compared to the equity it has from shareholders. A high debt-to-equity ratio may raise concerns regarding the firm's ability to meet its debt obligations, especially if cash flows are inconsistent. Thus, the interpretation of this ratio is crucial for assessing the overall risk profile of the company's capital structure.