Ratio Analysis & Cash Flow Flashcards

A credit analyst notices that a company's operating cash flow significantly exceeds net income each year. This pattern most likely indicates:

Answer: Strong cash earnings quality with healthy non-cash charges or favorable working capital management

Operating cash flow consistently exceeding net income typically signals high earnings quality, driven by substantial non-cash charges or efficient working capital management.

A company's net profit margin is 3% on revenues of $50 million. If revenue increases 10% while fixed costs remain constant and variable costs are 70% of revenue, how does this primarily affect credit analysis?

Answer: Operating leverage means profit growth will outpace revenue growth, improving coverage ratios

High operating leverage means incremental revenue above fixed costs flows largely to profit, improving margins and debt service coverage ratios as revenue grows.

Which of the following best describes 'sustainable growth rate' in the context of credit analysis?

Answer: The rate at which a company can grow while maintaining its current financial ratios using retained earnings only

The sustainable growth rate is the maximum rate a company can grow using only retained earnings without changing its leverage or equity ratios, important for assessing whether growth plans require external debt.

When normalizing EBITDA for credit analysis, which adjustment is most appropriate?

Answer: Excluding one-time gains and losses, restructuring charges, and non-recurring items to reflect run-rate earnings

Normalized EBITDA excludes truly non-recurring items to reflect sustainable operating performance, but analysts must carefully evaluate whether items are genuinely one-time.

A company's accounts payable balance decreased by $400,000 despite stable revenues. In the indirect method cash flow statement, this change is:

Answer: Subtracted from net income as a use of cash

A decrease in accounts payable means the company paid suppliers faster, using cash, so it is subtracted from net income in the operating cash flow section.

A company has total assets of $10 million, total liabilities of $7 million, and net income of $600,000. What is its return on assets (ROA)?

Answer: 6%

ROA = Net Income ÷ Total Assets = $600,000 ÷ $10,000,000 = 6%, measuring how efficiently assets generate profit.

In a leveraged buyout (LBO) scenario, a credit analyst evaluating debt serviceability would place the MOST emphasis on which metric?

Answer: Debt/EBITDA and free cash flow available for debt service

LBO credit analysis centers on debt/EBITDA leverage and free cash flow generation, as the business must service heavy acquisition debt from operating cash flows.