Future Business Leaders of America (FBLA) Agribusiness Practice Test

What is the outcome of a high debt-to-equity ratio?

1. Increased financial risk

2. Decreased liability

3. Increased asset liquidity

4. Better financial performance

The correct answer is: Increased financial risk

A high debt-to-equity ratio signifies that a company is using a larger amount of debt relative to its equity to finance its operations. This situation leads to increased financial risk for several reasons. First, with more debt comes a higher obligation to meet interest payments and repay the principal, which can strain cash flow, especially in times of economic downturn or reduced revenue. Increased reliance on borrowed funds can amplify the impact of poor performance or operational issues, potentially leading to financial distress or bankruptcy if the company cannot meet its obligations. Additionally, stakeholders, including investors and creditors, may view a high debt-to-equity ratio as a sign of increased risk, potentially affecting the company’s ability to secure additional financing in the future or leading to higher borrowing costs. This heightened risk may also discourage some investors who prefer companies with more conservative financial structures. Hence, a high debt-to-equity ratio is primarily associated with increased financial risk.