CCP Ratio Analysis & Cash Flow 2 — Questions and Answers
Question 1: A company has EBITDA of $500,000 and total debt of $2,000,000. What is its debt/EBITDA ratio, and how would a credit analyst typically interpret a ratio of 4.0x?
- 4.0x; generally acceptable for most industries
- 4.0x; considered high leverage requiring close monitoring (Correct answer)
- 0.25x; indicates strong debt coverage
- 2.5x; moderate leverage with adequate coverage
Correct answer: 4.0x; considered high leverage requiring close monitoring
Debt/EBITDA of 4.0x is generally considered high leverage, as most lenders prefer ratios below 3.0x–3.5x for investment-grade borrowers.
Question 2: Which component of the cash flow statement reflects payments for purchasing machinery and equipment?
- Operating activities
- Investing activities (Correct answer)
- Financing activities
- Non-cash activities
Correct answer: Investing activities
Capital expenditures for fixed assets like machinery and equipment are classified under investing activities in the cash flow statement.
Question 3: A company's accounts receivable days outstanding (DSO) increased from 35 to 55 days year-over-year. What does this most likely signal to a credit analyst?
- Improved collections efficiency
- Potential deterioration in receivables quality or collection problems (Correct answer)
- Faster revenue recognition
- Stronger customer relationships
Correct answer: Potential deterioration in receivables quality or collection problems
Rising DSO indicates customers are taking longer to pay, which may signal collection problems, customer financial stress, or looser credit terms.
Question 4: Free cash flow (FCF) is best defined as:
- Net income plus depreciation and amortization
- Operating cash flow minus capital expenditures (Correct answer)
- EBITDA minus interest expense and taxes
- Revenue minus all operating expenses
Correct answer: Operating cash flow minus capital expenditures
Free cash flow equals operating cash flow minus capital expenditures, representing cash available after maintaining and growing the asset base.
Question 5: A retail company has an inventory turnover ratio of 3x compared to an industry average of 8x. What does this suggest?
- The company is selling inventory very efficiently
- The company may have excess, slow-moving, or obsolete inventory (Correct answer)
- The company has superior purchasing power
- The company has a lean just-in-time model
Correct answer: The company may have excess, slow-moving, or obsolete inventory
An inventory turnover significantly below the industry average suggests the company holds excess inventory, which may be slow-moving or at risk of obsolescence.
Question 6: Which ratio measures a company's ability to pay interest expense from operating earnings?
- Current ratio
- Debt-to-equity ratio
- Interest coverage ratio (Correct answer)
- Quick ratio
Correct answer: Interest coverage ratio
The interest coverage ratio (EBIT ÷ interest expense) measures how many times operating earnings can cover interest obligations.
Question 7: A company shows positive net income but negative operating cash flow for two consecutive years. As a credit analyst, this pattern most likely indicates:
- Excellent accrual accounting practices
- Potential earnings quality concerns and liquidity risk (Correct answer)
- Aggressive but sustainable growth
- Strong non-cash revenue streams
Correct answer: Potential earnings quality concerns and liquidity risk
Sustained positive net income with negative operating cash flow suggests earnings may be inflated by accruals that are not converting to cash, a significant credit risk.
CCP Ratio Analysis & Cash Flow 2
A company has EBITDA of $500,000 and total debt of $2,000,000.
What is its debt/EBITDA ratio, and how would a credit analyst typically interpret a ratio of 4.0x?