Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which ratio would be most relevant to assess a company's ability to handle short-term lease obligations?

1. Debt to Equity Ratio

2. Fixed Charge Coverage Ratio

3. Gross Profit Margin

4. Operating Margin

The correct answer is: Fixed Charge Coverage Ratio

The Fixed Charge Coverage Ratio is particularly relevant for assessing a company's ability to manage short-term lease obligations due to its focus on a firm's capacity to cover fixed financial commitments, which include lease payments. This ratio evaluates how easily a company can meet its fixed charges, such as interest and lease obligations, by comparing its earnings before interest and taxes (EBIT) to its fixed charges. Since leases often represent a significant fixed cost for many companies, especially those with substantial leasing arrangements, this ratio provides insight into whether the company generates enough earnings to comfortably cover its lease obligations along with other fixed costs. A higher Fixed Charge Coverage Ratio indicates stronger financial health and a higher likelihood of a company meeting its short-term lease payments, making it a vital tool for stakeholders assessing financial stability in relation to lease liabilities. The other ratios – Debt to Equity, Gross Profit Margin, and Operating Margin – focus on different aspects of financial health, such as leverage, profitability, and operating efficiency, rather than specifically addressing the company's ability to manage short-term obligations. Therefore, they are less relevant in this context.