Certified Financial Management Specialist Practice Exam

Which type of ratios assess a firm's financing methods and debt repayment ability?

1. Profitability ratios

2. Market value ratios

3. Debt management ratios

4. Liquidity ratios

The correct answer is: Debt management ratios

Debt management ratios are specifically designed to evaluate a firm's leverage and its ability to manage its debt effectively. These ratios provide insight into how much debt a company is utilizing compared to its equity, as well as its ability to repay outstanding debt based on its income and cash flow. Common examples of debt management ratios include the debt-to-equity ratio and the interest coverage ratio. The debt-to-equity ratio shows the proportion of equity and debt used to finance a company's assets, while the interest coverage ratio assesses how well a company can pay interest expenses on outstanding debt with its earnings before interest and taxes (EBIT). These ratios are crucial for lenders and investors because they indicate the financial health of the company and its risk profile regarding debt obligations. High debt levels may pose a risk for potential default, while strong debt management ratios typically suggest a lower risk, indicating that the company is capable of managing its financing methods effectively and repaying its debts in a timely manner. In contrast, profitability ratios focus primarily on a company's ability to generate earnings relative to its sales, assets, or equity, market value ratios relate to the performance of the company in the stock market, and liquidity ratios measure the firm's capacity to meet short-term obligations but do not directly assess long