CME Financial Management & Budgeting 2 — Questions and Answers
Question 1: A company uses zero-based budgeting (ZBB). What is the primary distinguishing feature of this approach?
- Every expense must be justified from scratch each period (Correct answer)
- Prior year actuals serve as the baseline for all line items
- Only capital expenditures require justification
- Budget changes are limited to a fixed percentage increase
Correct answer: Every expense must be justified from scratch each period
ZBB requires managers to justify every expense anew each budget cycle rather than starting from the prior year's figures.
Question 2: Which financial ratio best measures a company's ability to meet short-term obligations using only its most liquid assets?
- Current ratio
- Quick ratio
- Cash ratio (Correct answer)
- Debt-to-equity ratio
Correct answer: Cash ratio
The cash ratio (cash + cash equivalents / current liabilities) uses only the most liquid assets, making it the most conservative short-term liquidity measure.
Question 3: When a budget is described as 'participative' or 'bottom-up,' what is the main advantage?
- It reduces total budget preparation time
- It increases manager buy-in and commitment to targets (Correct answer)
- It eliminates the need for budget revisions
- It guarantees alignment with corporate strategy
Correct answer: It increases manager buy-in and commitment to targets
Bottom-up budgeting improves motivation and commitment because managers who set their own targets feel greater ownership of results.
Question 4: A firm's EBITDA margin increased while its net profit margin decreased. Which scenario best explains this?
- Revenue increased faster than operating costs
- Interest expense and tax burden increased significantly (Correct answer)
- Depreciation and amortization decreased
- Cost of goods sold fell as a percentage of revenue
Correct answer: Interest expense and tax burden increased significantly
Rising interest or tax charges reduce net income without affecting EBITDA, causing the two margins to diverge.
Question 5: What does a negative operating cash flow combined with positive net income most likely indicate?
- The company is highly profitable and growing fast
- Working capital is being consumed, possibly by rising receivables or inventory (Correct answer)
- The company is generating strong free cash flow
- Depreciation charges are unusually high
Correct answer: Working capital is being consumed, possibly by rising receivables or inventory
When net income is positive but operating cash flow is negative, the company is likely building up receivables or inventory that consumes cash.
Question 6: In capital budgeting, the 'payback period' method is criticized primarily because it:
- Is too mathematically complex for most managers
- Ignores the time value of money and cash flows after payback (Correct answer)
- Always produces a shorter payback than NPV analysis
- Requires the weighted average cost of capital as an input
Correct answer: Ignores the time value of money and cash flows after payback
The payback period ignores the time value of money and any cash flows that occur after the initial investment is recovered.
Question 7: A rolling forecast differs from a traditional annual budget primarily in that it:
- Is prepared only once per year by senior finance staff
- Extends the forecast horizon continuously as each period passes (Correct answer)
- Focuses exclusively on capital expenditure planning
- Locks in targets that cannot be revised mid-year
Correct answer: Extends the forecast horizon continuously as each period passes
A rolling forecast is updated regularly so that the planning horizon always extends the same number of periods into the future.
CME Financial Management & Budgeting 2
A company uses zero-based budgeting (ZBB).
What is the primary distinguishing feature of this approach?