CCM Financial Management & Budgeting 3 — Questions and Answers
Question 1: What does the operating leverage ratio measure?
- The proportion of debt versus equity in the capital structure
- The sensitivity of operating income to changes in sales volume (Correct answer)
- The ratio of current assets to current liabilities
- The efficiency of accounts receivable collections
Correct answer: The sensitivity of operating income to changes in sales volume
Operating leverage measures how a percentage change in sales translates into a percentage change in operating income, driven by the mix of fixed versus variable costs.
Question 2: A credit manager reviews a customer's interest coverage ratio of 1.2. What risk does this present?
- Minimal risk; the ratio exceeds the breakeven threshold
- Moderate risk; the company barely covers its interest expense (Correct answer)
- No risk; any ratio above 1.0 is considered safe
- High liquidity risk unrelated to debt service
Correct answer: Moderate risk; the company barely covers its interest expense
An interest coverage ratio of 1.2 means earnings barely exceed interest obligations, leaving little buffer for earnings volatility and signaling moderate-to-high credit risk.
Question 3: Which financial statement best reveals whether a profitable company is generating sufficient cash to sustain operations?
- Income statement
- Balance sheet
- Statement of cash flows (Correct answer)
- Statement of retained earnings
Correct answer: Statement of cash flows
The statement of cash flows shows actual cash generated and used in operating, investing, and financing activities, revealing liquidity independent of accrual profits.
Question 4: In variance analysis, an unfavorable budget variance for sales revenue means:
- Actual sales exceeded budgeted sales
- Actual sales fell short of budgeted sales (Correct answer)
- Sales expenses were higher than expected
- The gross margin improved over budget
Correct answer: Actual sales fell short of budgeted sales
An unfavorable revenue variance occurs when actual revenue is less than the budgeted amount, negatively impacting the company's financial performance.
Question 5: A company wants to determine its break-even point in units. Which formula is correct?
- Fixed costs ÷ Contribution margin per unit (Correct answer)
- Total costs ÷ Selling price per unit
- Variable costs ÷ Contribution margin ratio
- Fixed costs × Variable cost ratio
Correct answer: Fixed costs ÷ Contribution margin per unit
Break-even units = Fixed costs ÷ Contribution margin per unit, where contribution margin equals selling price minus variable cost per unit.
Question 6: Which ratio measures how efficiently a company converts its inventory into sales?
- Current ratio
- Quick ratio
- Inventory turnover ratio (Correct answer)
- Receivables turnover ratio
Correct answer: Inventory turnover ratio
Inventory turnover (Cost of Goods Sold ÷ Average Inventory) indicates how many times a company sells and replaces its inventory within a period.
Question 7: A rolling 12-month budget differs from an annual budget primarily because it:
- Requires zero-based justification each month
- Is updated monthly to always cover a future 12-month horizon (Correct answer)
- Allocates costs based on activity drivers
- Fixes all revenue targets at the start of the fiscal year
Correct answer: Is updated monthly to always cover a future 12-month horizon
A rolling budget is continuously updated by adding a new future period as the most recent period ends, maintaining a constant forward-looking time horizon.
CCM Financial Management & Budgeting 3
What does the operating leverage ratio measure?