CCP CCP Financial Statement Analysis & Credit Decisions 1 — Questions and Answers
Question 1: When analyzing a potential customer's financial statements, which document most directly reveals the company's ability to generate cash to pay obligations?
- Income statement
- Balance sheet
- Statement of cash flows (Correct answer)
- Notes to financial statements
Correct answer: Statement of cash flows
The statement of cash flows shows actual cash generated from operations, investing, and financing activities — making it the most direct measure of a company's ability to pay debts.
Question 2: A buyer's financial statements show net income of $500K but operating cash flow of -$200K. What is the most likely explanation?
- The buyer is overpaying taxes
- Working capital is growing faster than earnings, consuming cash despite profitability (Correct answer)
- The buyer has excessive depreciation charges
- Revenue recognition is being understated
Correct answer: Working capital is growing faster than earnings, consuming cash despite profitability
When operating cash flow lags net income, it often signals that receivables, inventory, or other working capital components are expanding, absorbing cash generated from profitable sales.
Question 3: Which financial ratio directly measures a company's short-term liquidity without including inventory in the calculation?
- Current ratio
- Quick ratio (acid-test ratio) (Correct answer)
- Cash conversion cycle
- Debt-to-equity ratio
Correct answer: Quick ratio (acid-test ratio)
The quick ratio (cash + marketable securities + receivables ÷ current liabilities) excludes inventory because it may not be quickly convertible to cash, giving a more conservative liquidity view.
Question 4: A credit professional notes that a buyer's goodwill increased significantly year-over-year without a disclosed acquisition. This MOST likely indicates:
- Improved brand value from organic growth
- A possible accounting irregularity that warrants further investigation (Correct answer)
- Reclassification of fixed assets to intangibles
- Strong organic growth in customer relationships
Correct answer: A possible accounting irregularity that warrants further investigation
Under US GAAP, goodwill only arises from business acquisitions and cannot be internally generated; an unexplained increase is a red flag requiring clarification.
Question 5: Which of the following is a 'red flag' when reviewing a privately held buyer's financial statements?
- Audited financials prepared by a Big Four firm
- Reviewed financials with a material weakness disclosure
- Compiled financials with no assurance from the accountant (Correct answer)
- Tax returns that align with financial statement revenue
Correct answer: Compiled financials with no assurance from the accountant
Compiled financial statements carry no assurance — the accountant merely assembles management-provided data without verification, making them the weakest form of third-party financial documentation.
Question 6: What does a rising trend in a buyer's accounts payable days (DPO) suggest to a credit professional?
- The buyer is improving its cash conversion efficiency
- The buyer may be stretching payables due to liquidity pressure (Correct answer)
- The buyer is successfully negotiating better terms with suppliers
- The buyer's revenue growth is accelerating
Correct answer: The buyer may be stretching payables due to liquidity pressure
While higher DPO can reflect favorable supplier terms, a rising trend often signals the buyer is delaying payments because of cash flow stress — a key credit warning sign.
CCP CCP Financial Statement Analysis & Credit Decisions 1
When analyzing a potential customer's financial statements, which document most directly reveals the company's ability to generate cash to pay obligations?