What do leverage ratios indicate in a business?

Leverage ratios are critical financial metrics that help assess the degree to which a business relies on borrowed funds as compared to equity. They focus on understanding how much of a company's funding comes from creditors versus shareholders. When a company uses leverage effectively, it can amplify its returns on equity; however, it also indicates the level of risk associated with its debt obligations. High leverage can suggest a company is heavily financed through debt, which could be risky, especially during downturns, while low leverage might indicate a more conservative approach.

The other choices relate to different aspects of financial health. Profitability metrics, for example, assess a company's ability to generate earnings relative to its expenses. Liquidity ratios examine a company’s ability to meet its short-term obligations, and efficiency ratios focus on how well a company utilizes its assets to produce revenue. While these are all important areas of evaluation, they do not reflect the specific insights provided by leverage ratios regarding a company's capital structure and the distribution of financial responsibilities between creditors and shareholders.