CBS Financial Statement Analysis 3 — Questions and Answers
Question 1: Which ratio measures how efficiently a bankrupt company converts inventory to sales and is critical for liquidation valuation?
- Return on equity
- Inventory turnover ratio (Correct answer)
- Debt-to-equity ratio
- Interest coverage ratio
Correct answer: Inventory turnover ratio
Inventory turnover reveals how quickly inventory sells, which is essential when estimating liquidation proceeds from stock-in-trade.
Question 2: A Chapter 11 debtor's balance sheet shows goodwill of $50M. Under fresh-start accounting at emergence, what happens to pre-petition goodwill?
- It is retained at its original amount
- It is eliminated and new goodwill may be recorded based on reorganization value (Correct answer)
- It is immediately expensed as a reorganization cost
- It is reclassified as a liability subject to compromise
Correct answer: It is eliminated and new goodwill may be recorded based on reorganization value
Pre-petition goodwill is eliminated entirely under fresh-start accounting; new goodwill is only recognized if reorganization value exceeds fair value of net assets.
Question 3: In solvency analysis, which test compares the fair value of assets to the fair value of liabilities to determine insolvency?
- The cash flow test
- The capital adequacy test
- The balance sheet test (Correct answer)
- The going concern test
Correct answer: The balance sheet test
The balance sheet test defines insolvency as the condition where fair value of total liabilities exceeds fair value of total assets.
Question 4: When evaluating a reorganization plan, a creditor examines EBITDA projections. Why is EBITDA particularly useful in this context?
- It reflects actual cash tax payments
- It approximates cash generation before capital structure effects, useful for valuation (Correct answer)
- It includes working capital changes for liquidity assessment
- It is required by the Bankruptcy Code as the primary metric
Correct answer: It approximates cash generation before capital structure effects, useful for valuation
EBITDA strips out financing costs and non-cash charges, making it a useful proxy for operating cash flow in enterprise valuations.
Question 5: A preference analysis requires determining whether a payment made 90 days before bankruptcy was made while the debtor was insolvent. Which financial documents are most relevant?
- Post-petition monthly operating reports
- Pre-petition balance sheets and solvency analyses (Correct answer)
- The confirmed reorganization plan
- Post-emergence income statements
Correct answer: Pre-petition balance sheets and solvency analyses
Pre-petition balance sheets help establish whether assets exceeded liabilities at the time of the alleged preferential transfer.
Question 6: Which of the following best describes 'enterprise value' as used in a Chapter 11 plan of reorganization?
- The book value of equity plus long-term debt
- The total value of the reorganized debtor available to satisfy all stakeholders (Correct answer)
- The liquidation value of tangible assets only
- The par value of all pre-petition debt claims
Correct answer: The total value of the reorganized debtor available to satisfy all stakeholders
Enterprise value in a reorganization context represents the going-concern value of the reorganized entity used to determine distributions to creditors and equity.
Question 7: A debtor's monthly operating report shows operating cash outflows consistently exceeding inflows. What does this signal to a bankruptcy court?
- The debtor is successfully restructuring operations
- The debtor may be unable to fund operations through reorganization (Correct answer)
- The debtor has excess working capital
- The debtor's secured creditors are fully protected
Correct answer: The debtor may be unable to fund operations through reorganization
Persistent operating cash burn raises doubts about the debtor's ability to fund the reorganization process and suggests conversion to Chapter 7 may be warranted.
CBS Financial Statement Analysis 3
Which ratio measures how efficiently a bankrupt company converts inventory to sales and is critical for liquidation valuation?