Certified Financial Management Specialist Practice Exam

What does a low leverage ratio mean for a company's financial structure?

1. More debt financing

2. More equity financing

3. Higher financial risk

4. Lower growth rates

The correct answer is: More equity financing

A low leverage ratio indicates that a company is utilizing less debt relative to its equity. This means that the company is more reliant on equity financing as compared to debt financing. A lower leverage ratio favors a more conservative financial structure, where the company is less dependent on borrowed funds to finance its operations and growth, reducing the burden of interest payments. This can be viewed positively, as it can enhance the company's financial stability and lower its financial risk profile. Additionally, a lower dependence on debt might make it easier for the company to secure further financing if needed. In contrast, a high leverage ratio indicates greater reliance on debt, which can increase the financial risk associated with variability in interest rates and repayment obligations. This situation could lead to higher financial risk if the company faces challenges in cash flow or profitability, as it has greater obligations to meet.