CCM Credit Risk Evaluation 2 — Questions and Answers
Question 1: A company has a current ratio of 0.8 and a quick ratio of 0.4. What does this indicate about its short-term liquidity?
- Strong liquidity with ample current assets
- Potential liquidity problems with heavy reliance on inventory (Correct answer)
- The company is profitable but capital-intensive
- The company has excessive long-term debt
Correct answer: Potential liquidity problems with heavy reliance on inventory
A current ratio below 1.0 and a quick ratio of 0.4 indicate the company relies heavily on inventory to meet short-term obligations, signaling liquidity risk.
Question 2: Which financial metric measures how efficiently a company collects its receivables?
- Debt-to-equity ratio
- Days Sales Outstanding (DSO) (Correct answer)
- Gross profit margin
- Interest coverage ratio
Correct answer: Days Sales Outstanding (DSO)
DSO measures the average number of days a company takes to collect payment after a sale, indicating receivables management efficiency.
Question 3: In credit risk assessment, a 'concentration risk' refers to:
- A borrower having too many creditors
- Excessive exposure to a single customer, industry, or geography (Correct answer)
- High interest rate exposure in a portfolio
- The risk of currency fluctuation in international trade
Correct answer: Excessive exposure to a single customer, industry, or geography
Concentration risk arises when a credit portfolio has excessive exposure to one customer, sector, or region, amplifying potential losses if that segment defaults.
Question 4: A buyer requests Net-60 terms but your analysis shows their DSO is 85 days. What is the most appropriate action?
- Approve Net-60 terms as requested
- Decline all credit and require cash in advance
- Approve with a reduced credit limit and monitor closely (Correct answer)
- Extend Net-90 terms to match their payment behavior
Correct answer: Approve with a reduced credit limit and monitor closely
Approving with a reduced limit and close monitoring balances the business relationship while mitigating the elevated payment risk indicated by the high DSO.
Question 5: Which of the following best describes 'systematic risk' in a credit portfolio?
- Risk specific to an individual borrower's operations
- Market-wide risk that affects all borrowers simultaneously (Correct answer)
- Risk arising from fraud or misrepresentation
- The risk of a single large account defaulting
Correct answer: Market-wide risk that affects all borrowers simultaneously
Systematic risk is macro-level risk (economic downturns, interest rate changes) that impacts all borrowers and cannot be eliminated through diversification.
Question 6: When evaluating a new business with no credit history, which source provides the MOST relevant credit insight?
- A credit bureau report on the business entity
- Personal credit reports of the business owners (Correct answer)
- Industry trade payment data from NACM or similar
- Published financial statements for the prior year
Correct answer: Personal credit reports of the business owners
For a new business without its own credit history, the personal credit of the owners is the most direct indicator of likely payment behavior.
Question 7: A customer's EBITDA is $500,000 and their total debt is $2,500,000. What is their debt/EBITDA ratio and what does it suggest?
- 0.2x, indicating very low leverage
- 5.0x, indicating high leverage and potential repayment risk (Correct answer)
- 2.5x, indicating moderate and acceptable leverage
- 0.5x, indicating strong debt coverage
Correct answer: 5.0x, indicating high leverage and potential repayment risk
A debt/EBITDA of 5.0x is considered high leverage, suggesting the company would need five years of current earnings to repay its debt, raising repayment risk.
CCM Credit Risk Evaluation 2
A company has a current ratio of 0.8 and a quick ratio of 0.4.
What does this indicate about its short-term liquidity?