Which of the following would be the most useful to an analyst trying to assess the credit worthiness of a company? A. return measures related to net income B. return measures related to operating cash flow C. information relating to the scale and diversity of a company’s opertions D. information relating to operational efficiency of the company’s operations?
I’ll be back in 10 minutes with the answer. I have to go to the store for my wife.
is it C? cause numbers in all the others can be manipulated.
b
I would say B or a second close runner up A - C & D looks out of place here
Credit analyst are typically interested in the balance sheet as well as a firm’s ability to meet annual debt service payments, hence why EBIT/ Debt Service (i.e. the debt service coverage ratio) is one of the first metrics discussed when considering a credit rating (next in line being liquidity) A & B are out because they are more equity concepts (i.e. returns) I would eliminate C as well. Although both items can help in better evaluating credit rating, alone they are meaningless if the company cannot meet debt service or liquidity demands (see first para) Therefore D must be the answer since operational efficiency (i.e. EBIT ratios) are very telling about a firm’s ability to meet fixed costs (including debt service)
very good point Char-Lee, when you put it like that D seems like a correct response. I am still sticking with my answer B though if a company doesnt generate enough cash (assuming quality earnings, and no decrease non-cash working capital) they would not be able to service their debt, short-term or longer term very interested to see what this answer is
getterdone Wrote: ------------------------------------------------------- > very good point Char-Lee, when you put it like > that D seems like a correct response. > > I am still sticking with my answer B though > > if a company doesnt generate enough cash (assuming > quality earnings, and no decrease non-cash working > capital) they would not be able to service their > debt, short-term or longer term > > very interested to see what this answer is. Nicely put getterdone, I was thinking along similar lines when I picked B
I was thinking that scale and diversity of operations are better indicators of firm’s ability to manage unsystematic risk. What if E in EBIT is manipulated with one time “surprise” earnings from non-core business operations?
Going D. Operational efficiency is asset turnovers, etc. right? They have to be turning that out to generate cash fast enough and pay creditors.
When I think credit worthiness, I think solvency, ie: debt to equity, can they pay their debts in time." But, debt to equity isn’t one of the choices. The answer is below. It’s a bad explanation because it doesn’t actually say what the answer is. “Credit analysis is concerned with a company’s debt-paying ability. Returns to creditors are normally paid in cash, so the company’s ability to generate cash internally is the most important factor in credit analysis.” My guess is D because it is the only choice that concerns liquidity, efficiency, which is close to solvency. What do you think?
I think B.
I think its B
Why do you think it’s B.
yancey Wrote: ------------------------------------------------------- > Why do you think it’s B. Because when you do a credit analysis you are mainly focused on the short term capability of the company to repay your debt, hence the operating cash flow shows the capacity of a company to generate liquidity from its core business. If you have an operating cash outflow…that is not a good sign…
credit ratings refer to the companys ability to repay the bonds on time without default. A demontration of a strong cashflow position is a consideration in my opinion. in terms of manipulation i think cashflows can not be manipulated compared to the rest of the comparative.
yancey Wrote: ------------------------------------------------------- > “Credit analysis is concerned with a company’s > debt-paying ability. Returns to creditors are > normally paid in cash, so the company’s ability to > generate cash internally is the most important > factor in credit analysis.” > ------------------------------------------- I think the explanation is clear, Cash is the King. creditor need the real cash , not high NI on paper. ability to generate cash internally and regularly is the key factor for credit analysis. my choice is B. What if A is total Cashflow? shall we pick A? i will still pick B, because it is from regular operating. the total CF may include CFI and CFF inflow, then looks better than from regular operating. >
Cash is king! That’s the Credit Mantra.
B and not A, why? The company may generate negative net income or just breaks even, but as long as it is able to generate enough cash to fund its operations and pay its creditors it will continue to function in the short-run, eventually in the long run the company would’ve to generate positive net income or else it will go out of business. Does this makes any sense? or should I just take some time off to rest after spending way too much time on AF website?
Easiest way to think about it from a credit analyst perspective is, which of the options would you lend against. Would you lend against ‘efficiency’ or ‘accounting profit’ or "scale and diversity’… if you would, good luck getting repaid. Only thing that pays the bills when interest is due is cash from operations (less capex and dividends to be more picky)… but in the worst conditions, all you need is cash from ops.