A company has assets of $10 million and liabilities of $7 million. Liabilities include $4 million in accounts payable, $2 million in long-term notes payable and $1 million in other non-current liabilities. If a financial web site uses long-term debt rather than total liabilities to calculate the company's debt-to-assets ratio, the web site will report a ratio of:
A) 0.5, which would correctly state financing risk.
B) 0.4, which would suggest more financing risk than it actually has.
C) 0.3, which would suggest less financing risk than it actually has.
D) 0.3, which would suggest more financing risk than it actually has.

Question

Quizplus · Accepted Answer

The correct formula for debt-to-assets ratio is total liabilities divided by total assets. Using long-term debt instead of total liabilities will result in a lower number, which means less financing risk than it actually has. 
The calculation using long-term debt only would be:
Long-term debt = $2 million
Total assets = $10 million
Debt-to-assets ratio = $2 million / $10 million = 0.2
Therefore, the web site would report a ratio of 0.2, which would suggest less financing risk than it actually has.

A Company Has Assets of $10 Million and Liabilities of $7