To show low leverage, which ratio should be less than 1?

• A. Total liabilities / net worth
• B. Acid test
• C. Current ratio
• D. Return on total assets

Answer: (A)

Leverage is about how much of a company’s funding comes from debt versus the owners’ equity. To show low leverage, you want a small amount of debt relative to equity. The ratio that compares total liabilities to net worth does exactly that: it measures debt burden against the equity cushion. If this ratio is less than 1, liabilities are smaller than net worth, meaning the company has more equity than debt and a lighter debt load. For example, liabilities of 400 with net worth of 600 give a ratio of 0.67, indicating low leverage; liabilities of 900 with net worth 600 give a ratio of 1.5, indicating higher leverage.

The other ratios serve different purposes. Current ratio and acid-test ratio assess liquidity—short-term ability to cover obligations—rather than long-term debt burden. Return on total assets is a profitability measure, not a leverage indicator. So the ratio of total liabilities to net worth is the one that should be less than 1 to show low leverage.