Question

1. What is leverage and how does it work? What is the main concern about using it? 2. Why do we need the quick ratio when we have the current ratio? 3. Why do people view having too much debt as risky? If you were interested in determining whether a company had too much debt, what measure would you use? Why? How much debt do you think would generally be considered too much?

Answer 1

Ans 1) Debt taken by company is leverage , it provide capital to business entity for expansion , investment and other business activities. Main concern with the debt is it put more pressure on the top line of company and may decrease the profit and in adverse cases it lead to huge losses to the businesses.

Ans 2) Quick ratio is better matrices when there is an urgent need of money but in case current ration there is a possibility that company will not able to convert whole current asset into cash in very short term which may lead to payment default in some cases.

Ans 3) Debt is double edge sword when company is performing well then debt can increase the return on equity but if company is facing adverse time this debt will eat the profit of company, that's why it is very important to manage debt carefully. And too much debt will lead to more risk since company has to may more interest.

Debt ratio is a good measure to check whether company has too much debt or not,

Debt varies sector wise thus it is better to have average debt of that sector in which company is operating if it is more than that it will be considered too much.