What does a high debt ratio indicate about financial risk?

A high debt ratio indicates higher financial risk because it reflects a greater proportion of a company's assets being financed through debt rather than equity. When a company relies heavily on debt to fund its operations and growth, it becomes more vulnerable to fluctuations in earnings and broader economic conditions. This increased leverage can lead to amplified risks during downturns, as fixed-interest obligations must still be met regardless of a company's revenue performance.

In essence, a high debt ratio suggests that a significant portion of the firm's financing comes with obligations that must be repaid, which can strain cash flow and limit financial flexibility. Consequently, if earnings decline or unexpected expenses arise, a highly leveraged company may struggle more than its less leveraged counterparts, increasing the overall financial risk associated with its operations.