Future Business Leaders of America (FBLA) Agribusiness Practice Test

What does it mean if a business has more liabilities than assets?

1. The business is highly liquid

2. The owner's equity is negative and the business is insolvent

3. The business has high cash reserves

4. The firm is well-established with strong equity

The correct answer is: The owner's equity is negative and the business is insolvent

When a business has more liabilities than assets, it indicates that the total amount the business owes (liabilities) exceeds the total value of what the business owns (assets). This situation leads to negative owner's equity, meaning the owners have made an investment in the business that is less than the debt owed. In accounting terms, owner's equity is calculated as the difference between assets and liabilities. Thus, if liabilities are greater than assets, the owner's equity will indeed be negative. This condition often suggests that the business is insolvent, meaning it is unable to meet its financial obligations as they come due. Insolvency can lead to severe financial difficulties, including bankruptcy, depending on the jurisdiction and other factors involved. Understanding the implications of negative equity is crucial for assessing a business's financial health, as it represents a significant risk for both owners and creditors.