CCM Financial Statement Analysis 2 — Questions and Answers
Question 1: A company's quick ratio is 0.8 while its current ratio is 2.1. What does this significant gap most likely indicate?
- The company has strong liquidity across all asset types
- The company holds a large amount of inventory relative to current liabilities (Correct answer)
- The company has excessive cash balances
- The company's accounts receivable are slow to collect
Correct answer: The company holds a large amount of inventory relative to current liabilities
A large gap between the current ratio and quick ratio indicates inventory makes up a substantial portion of current assets, since inventory is excluded from the quick ratio.
Question 2: Which financial statement best shows a company's ability to generate cash from its core operations?
- Balance sheet
- Income statement
- Statement of cash flows — operating activities section (Correct answer)
- Statement of stockholders' equity
Correct answer: Statement of cash flows — operating activities section
The operating activities section of the cash flow statement isolates cash generated or consumed by the company's primary business operations.
Question 3: A credit analyst notices a company's days sales outstanding (DSO) increased from 35 to 58 days over two years. What is the most likely concern?
- The company is collecting receivables too quickly
- Customers are taking longer to pay, signaling potential collection problems (Correct answer)
- The company has reduced its credit sales
- Inventory turnover has improved significantly
Correct answer: Customers are taking longer to pay, signaling potential collection problems
Rising DSO indicates customers are taking longer to pay, which could signal collection difficulties, deteriorating customer quality, or loosened credit standards.
Question 4: Under the indirect method of preparing the cash flow statement, depreciation is added back to net income because:
- It represents an actual cash inflow from asset sales
- It is a non-cash expense that reduced net income but did not use cash (Correct answer)
- It increases the company's tax liability
- It reduces accounts payable balances
Correct answer: It is a non-cash expense that reduced net income but did not use cash
Depreciation is a non-cash charge that reduces net income on the income statement but involves no actual cash outflow, so it is added back under the indirect method.
Question 5: A company reports EBITDA of $5M but operating cash flow of only $1.2M. Which factor most likely explains this large discrepancy?
- The company has very low capital expenditures
- Significant increases in working capital are consuming cash (Correct answer)
- The company has no debt obligations
- Tax payments are unusually low
Correct answer: Significant increases in working capital are consuming cash
Large increases in working capital (e.g., rising receivables or inventory) can absorb cash and create a wide gap between EBITDA and actual operating cash flow.
Question 6: What does a negative tangible net worth indicate about a company?
- The company has more tangible assets than total liabilities
- Intangible assets and goodwill exceed total equity, suggesting high leverage or past acquisitions financed by debt (Correct answer)
- The company has strong collateral available to creditors
- Operating income exceeds interest expense
Correct answer: Intangible assets and goodwill exceed total equity, suggesting high leverage or past acquisitions financed by debt
Negative tangible net worth means that when intangibles are removed from equity, liabilities exceed tangible assets, a warning sign for creditors assessing collateral coverage.
Question 7: Which ratio directly measures how efficiently a company converts its assets into revenue?
- Debt-to-equity ratio
- Asset turnover ratio (Correct answer)
- Gross profit margin
- Interest coverage ratio
Correct answer: Asset turnover ratio
The asset turnover ratio (net sales ÷ total assets) measures how efficiently management uses its asset base to generate revenue.
CCM Financial Statement Analysis 2
A company's quick ratio is 0.8 while its current ratio is 2.1.
What does this significant gap most likely indicate?