A rising liquidity ratio could indicate prudent management, but if it rises significantly above 1:1, which could be an issue?

A rising liquidity ratio could indicate prudent management, but if it rises significantly above 1:1, which could be an issue?

• A. It indicates higher profits.
• B. It indicates accounts payable delays.
• C. It could mean too much cash tied up in liquid assets.
• D. It guarantees insolvency risk reduced to zero.

Answer: (C)

A rising liquidity ratio shows the company has more current assets relative to current liabilities, pointing to a stronger short-term cash position and safer ability to meet obligations. But if that ratio climbs well above 1:1, the issue is not risk of insolvency—it’s that too much cash and other liquid assets may be sitting idle. When cash is tied up in liquid assets, it can’t be put to work earning returns, which means inefficient use of resources and potentially lower profitability. Other options don’t fit as well: higher profits aren’t indicated by a higher liquidity ratio; delays in accounts payable would typically push the ratio down rather than up; and no ratio can guarantee insolvency risk is zero—the business could still face solvency issues despite a high liquidity ratio.

A rising liquidity ratio shows the company has more current assets relative to current liabilities, pointing to a stronger short-term cash position and safer ability to meet obligations. But if that ratio climbs well above 1:1, the issue is not risk of insolvency—it’s that too much cash and other liquid assets may be sitting idle. When cash is tied up in liquid assets, it can’t be put to work earning returns, which means inefficient use of resources and potentially lower profitability.

Other options don’t fit as well: higher profits aren’t indicated by a higher liquidity ratio; delays in accounts payable would typically push the ratio down rather than up; and no ratio can guarantee insolvency risk is zero—the business could still face solvency issues despite a high liquidity ratio.