Credit Analysis and Lending Flashcards

Which financial ratio best measures a borrower's ability to service debt from operating cash flow?

Answer: Debt service coverage ratio (DSCR)

DSCR compares net operating income to total debt service, directly measuring cash flow adequacy for loan repayment.

In commercial lending, a 'covenant' is best described as:

Answer: A contractual condition borrowers must maintain

Loan covenants are contractual conditions (affirmative or negative) that borrowers agree to maintain to protect the lender's position.

A borrower's working capital is calculated as:

Answer: Current assets minus current liabilities

Working capital equals current assets minus current liabilities and measures short-term liquidity and operational efficiency.

Which type of loan structure is most appropriate for financing a seasonal business with fluctuating revenue?

Answer: Revolving line of credit

A revolving line of credit allows borrowers to draw and repay funds as needed, matching the cash flow cycles of seasonal businesses.

The 'acid-test ratio' differs from the current ratio because it excludes:

Answer: Inventory

The acid-test (quick) ratio excludes inventory because it is the least liquid current asset and may not be quickly converted to cash.

When a lender takes a 'second lien' position on collateral, it means:

Answer: The lender's claim is subordinate to a first-lien holder

A second lien holder is paid only after the first lien holder is fully satisfied in the event of default or liquidation.

Which credit risk concept refers to the total exposure a bank has to a single borrower or related group?

Answer: Concentration risk

Concentration risk arises when a large portion of credit exposure is held with a single borrower or correlated group, amplifying potential losses.