Which of the following is a common credit risk factor?

• A. High leverage.
• B. Strong profitability.
• C. High liquidity.
• D. Rapid growth with low risk.

Answer: (A)

High leverage is a common credit risk factor because debt financing creates fixed obligations that must be met regardless of how the business performs. When a company carries a heavy debt load, a dip in sales or margins directly reduces cash available for interest and principal payments, increasing the risk of default or the need for distress financing. Leverage magnifies how earnings volatility affects the company: during good times it can boost returns, but in downturns it tightens cash flow, squeezes liquidity, and makes covenant breaches more likely. Lenders focus on debt service coverage and the firm’s ability to withstand shocks, and higher leverage reduces that cushion between operating income and debt obligations, elevating default risk and liquidity stress.

Profitability generally lowers risk by improving debt servicing capacity, while high liquidity provides a buffer to meet obligations. Rapid growth with low risk is not a typical risk factor on its own, because growth often requires financing and can strain resources if not supported by solid cash flows.