Certified Supply Chain Professional (CSCP) Practice Exam

What do leverage ratios measure in a business context?

1. The proportion of cash flow generated from sales

2. The extent of debt used to finance a business

3. The efficiency of asset usage in generating revenues

4. The liquidity of current assets compared to liabilities

The correct answer is: The extent of debt used to finance a business

Leverage ratios are critical financial metrics that assess the extent to which a business finances its operations and growth through debt as opposed to equity. Specifically, these ratios provide insight into a company's financial structure and its ability to meet financial obligations. When a business uses debt, it can amplify potential returns on equity, but it also increases financial risk, particularly if cash flows do not support the debt levels. The focus of the leverage ratio is primarily on the relationship between debt and equity. Common leverage ratios include the debt-to-equity ratio, which directly compares total liabilities to shareholders' equity, and the debt ratio, which measures total debt relative to total assets. A higher leverage ratio indicates that a company is more heavily financed by debt, which can impact its risk profile and financial stability. In contrast, the other options deal with different aspects of financial performance. While cash flow generated from sales relates to operational efficiency, asset usage efficiency, and liquidity comparisons involve how well a company can manage its short-term obligations, they do not specifically highlight the relationship between debt and overall financing in the same direct manner that leverage ratios do.