Finance for Non-Finance Managers Financial Ratios 5 — Questions and Answers
Question 1: Two companies have the same net profit margin but different ROEs. The company with the higher ROE most likely has:
- Lower revenue
- Higher financial leverage or greater asset efficiency (Correct answer)
- A lower tax rate
- Fewer shares outstanding
Correct answer: Higher financial leverage or greater asset efficiency
Per the DuPont framework, ROE = Net Margin × Asset Turnover × Equity Multiplier, so a higher ROE with equal margins implies greater leverage or better asset utilization.
Question 2: A company's cash conversion cycle (CCC) is negative. This generally means:
- The company is losing money on every sale
- The company collects cash from customers before it has to pay its suppliers (Correct answer)
- The company has more liabilities than assets
- The company's inventory turnover is very low
Correct answer: The company collects cash from customers before it has to pay its suppliers
A negative CCC means the business receives customer payments faster than it must pay suppliers, effectively using supplier financing to fund operations — a powerful liquidity advantage.
Question 3: The price-to-book (P/B) ratio compares a company's market value to its:
- Annual revenue
- Book value of shareholders' equity (Correct answer)
- Total assets
- Earnings per share
Correct answer: Book value of shareholders' equity
P/B ratio = Market Price per Share / Book Value per Share, where book value represents shareholders' equity as recorded on the balance sheet.
Question 4: A company reports EBITDA of $1,200,000 and total debt of $4,800,000. Its Debt/EBITDA ratio is:
- 0.25x
- 4x (Correct answer)
- 6x
- 2.5x
Correct answer: 4x
Debt/EBITDA = $4,800,000 / $1,200,000 = 4x, meaning it would take 4 years of current EBITDA to pay off the debt, a common leverage benchmark used by lenders.
Question 5: Which of the following best explains why two companies in the same industry can have very different current ratios without one necessarily being in better financial health?
- Different tax rates affect net income differently
- One company may manage working capital more efficiently, needing less buffer (Correct answer)
- Larger companies always have higher current ratios
- Current ratios are only meaningful for manufacturers
Correct answer: One company may manage working capital more efficiently, needing less buffer
An efficient company with fast inventory turnover and short collection cycles needs less current-asset cushion, so a lower current ratio may reflect operational strength, not weakness.
Question 6: When analyzing a company's profitability trend, which sequence of ratios provides the most complete picture from revenue to bottom line?
- P/E → ROE → EPS
- Gross margin → Operating margin → Net margin (Correct answer)
- Asset turnover → Debt-to-equity → Current ratio
- Inventory turns → DSO → DPO
Correct answer: Gross margin → Operating margin → Net margin
Moving from gross margin (after COGS) to operating margin (after operating expenses) to net margin (after all costs) traces profitability through each layer of the income statement.
Question 7: A high dividend payout ratio combined with a high debt-to-equity ratio could be a concern because:
- The company is retaining too much cash for reinvestment
- The company may be borrowing to fund dividends rather than using genuine profits (Correct answer)
- High dividends always indicate strong earnings quality
- Debt and dividends are unrelated financial metrics
Correct answer: The company may be borrowing to fund dividends rather than using genuine profits
Paying out a high proportion of earnings as dividends while carrying heavy debt suggests the company may be using borrowed funds to sustain dividend payments, which is unsustainable.
Finance for Non-Finance Managers Financial Ratios 5
Two companies have the same net profit margin but different ROEs.
The company with the higher ROE most likely has: