Question

Can a ratio be too high or too low? Why? Or why not? Think debt to equity and then the current ratio.

Answer 1

Debt equity ratio

• It is computed as Total Debt/Total Equity.
• If the ratio is too high, it implies more debt and less equity. The entity will be in financial burden to repay its debt due to less equity.
• If the ratio is too low, it implies less debt and more equity. The entity has more investment opportunities.
• The Debt equity ratio should not be too high and too low. The ideal debt equity ratio is 2:1.

Current ratio

• It is computed as Total Current Assets/Total Current Liabilities.
• If the ratio is too high, it implies more current assets and less current liabilities. The entity is good in managing its working capital cash flow.
• If the ratio is too low, it implies less current assets and more current liabilities. The entity is poor in managing its working capital cash flow.
• The current ratio should not be too high and too low. The ideal current ratio is 2:1.