CRC Flashcards
1
Q
. Which of the following are characteristics of the allowance method of accounting for bad debts?
I. Probable losses are estimated periodically
II. Write-offs are expensed when losses actually occur
III. Periodic contributions to a bad debt allowance are made
IV. Write-offs reduce only the gross receivables on the balance sheet
A
c. I & III
2
Q
All of the following factors impair the quality of an asset as a potential source of loan repayment EXCEPT:
A
Low historical cost basis of the asset from using accelerated depreciation
3
Q
All of the following are methods of accounting for inventory EXCEPT:
A
Net realizable value
4
Q
Which of the following entities is responsible for paying taxes directly to the IRS?
A
Regular corporation
5
Q
Under SFAS 115 marketable securities may be classified in all of the following ways on a financial statement EXCEPT:
A
Investment securities
6
Q
When interpreting the authenticity of a manufacturer’s cost of goods sold, all of the following are critical to the analysis EXCEPT:
A
a. The trend of cost of goods sold in relation to sales
b. The method of accounting used for depreciation
c. The timeliness of payments for raw materials
d. The accuracy of beginning and ending inventory values
7
Q
In a time of moderate inflation, which inventory accounting method would lead to the highest level of reported profit?
A
FIFO
8
Q
A company that collects payment in advance of delivering goods or performing services will report which of the following on its financial statements?
A
A liability titled “deferred revenues” that decreases as goods are delivered or services are performed
9
Q
Which of the following circumstances would NOT be treated as a contingency?
A
A company signs a non-cancelable lease on a fleet of delivery trucks
10
Q
When recording “Available for sale” securities, which of the following is NOT a requirement?
A
The securities are designated for sale in the short term
11
Q
All of the following are common characteristics of subordinated loans EXCEPT:
a. A two-part agreement between lenders to a company gives one lender payment preference over the other
b. The subordinated lender agrees to deferral of all principal payments until the senior lender has been fully repaid
A
??
12
Q
All of the following forms of organization expose their owners to personal liability for the business’s obligations EXCEPT:
A
Proprietorship
13
Q
When evaluating a company’s current assets, which of the following are expected to convert to cash during the operating cycle? I. Accounts receivable II. Inventory III. Prepaid expenses IV. Deferred tax assets
A
I & II
14
Q
Deferred tax assets can arise from which of the following circumstances?
I. The company had prior losses on its tax returns
II. The company uses differing methods of reporting depreciation on its financial statements and its tax returns
III. The company recognizes an expense on its financial statements before it can be recognized on its tax returns
IV. The company reports lower income on its tax return than on its financial statement
A
I & III
15
Q
All of the following events will affect the level of retained earnings in a business EXCEPT:
a. The business earns profits
b. The business loses money
c. The business sells stock
d. The business pays dividends
A
c. The business sells stock
16
Q
- Which of the following circumstances might lead to concern about the authenticity of a company’s revenues?
I. The company records revenue when a complete order is shipped
II. The company provides a six-month warranty on parts and labor for products sold
III. The company places goods on consignment with a retailer for sale
IV. The company sells raw materials to a wholly owned subsidiary.
a. I & III
b. II & IV
c. I, II & III
d. II, III & IV
A
D ?
17
Q
All of the following expenses may properly be capitalized EXCEPT:
a. Construction of a headquarters
b. Cost of developing a new product
c. Purchase of inventory
d. Purchase of a multi-year insurance policy
A
c. Purchase of inventory
18
Q
When evaluating a company’s existing liabilities, which of the following is LEAST important to a lender’s analysis?
A
Interest rate a competitor bank would be willing to offer
19
Q
Which of the following characteristics explains why a record company’s copyrighted music has more value as a repayment source than its other intangible asset, which is goodwill?
I. Copyrighted music is not subject to impairment tests
II. Copyrighted music is a separable asset
III. The music could be licensed outside the company
IV. The music has significant in-use value
A
II, III & IV
II. Copyrighted music is a separable asset
III. The music could be licensed outside the company
IV. The music has significant in-use value
20
Q
When assessing the sustainability of a company’s revenues, which of the following areas should be considered?
I. The composition of sales by type of product or service
II. The company’s share of the total market for its goods or services
III. Change in prices charged relative to the rate of inflation
IV. Growth in operating costs required to support sales
a. I & IV
b. I, II & III
c. II, III & IV
d. I, II, III & IV
A
D ?
21
Q
Which of the following reasons for sales growth would be LEAST desirable when assessing the sustainability of a company’s revenues?
a. The company has added some features to its product that have allowed for a price increase.
b. A reconfigured production process has led to increased unit production.
c. The company has extended its payment terms from 30 to 45 days.
d. The company produces a component that is a required part in another company’s latest successful product offering.
A
a. The company has added some features to its product that have allowed for a price increase.
b. A reconfigured production process has led to increased unit production.
c. The company has extended its payment terms from 30 to 45 days.
d. The company produces a component that is a required part in another company’s latest successful product offering.
22
Q
A lease must be accounted for as a capital lease if which of the following tests are met?
I. The lessee may purchase the asset for a nominal amount at the end of the lease term
II. The term of the lease equals 75% or more of the leased asset’s estimated useful life
III. The lessee is required to pay for any repairs to the leased asset
IV. The present value of lease payments is at least 90% of the asset’s fair market value
A
I, II & IV
I. The lessee may purchase the asset for a nominal amount at the end of the lease term
II. The term of the lease equals 75% or more of the leased asset’s estimated useful life
IV. The present value of lease payments is at least 90% of the asset’s fair market value
23
Q
Cavendish Computers is a distributor of computers and accessories to corporate accounts. Based on the changing needs of its customers, products are frequently returned before payment is received. The company has a permanent working capital facility with Your Bank. The advance rates on the line are 80% on A/R and 50% on inventory. Which of the following is most likely to occur if the revolver remains fully drawn?
A
The company may not be able to repay the bank
24
Q
New Vision Manufacturing produces commercial kitchen ware. The company’s adjusted working capital to sales ratio has increased from 15% to 24% over the last 3 years. Which of the following is most likely the cause of the change in the ratio?
A
Increase in accounts receivable days
25
3) Customer 1-30 days 31-60 days 61+ days Total
A 1,500,000 50,000 10,000 1,560,000
B 300,000 25,000 40,000 365,000
C 500,000 150,000 50,000 700,000
D 100,000 8,600 0 108,600
E 87,800 300,000 0 387,800
Total 2,487,800 533,600 100,000 3,121,400
The above table represents the A/R aging for Bayfield Medical Supplies, a distributor of medical supplies to hospitals and physicians. The company has a $52MM line of credit with Your Bank. Draws on the line are calculated as follows: Advance rate: 50% of eligible A/R, Ineligible accounts: 61+ days of invoice, 10% cross age (if 10% of a customer’s accounts is 61+ days, the entire receivable is ineligible). Based on the above information, which of the following represents the maximum amount of money this company may borrow from Your Bank?
a. $1,461,400
26
```
Sabre Manufacturing produces sheet components used in the production of washing machines and dryers. Revenues are $72MM. The following are highlights from the company’s balance sheet (in 000’s).
Cash 400
Short Term Debt 1,000
Accts Rec 5,000
CMLTD 250
Inventory 7,000
Accts Payable 4,000
Other C/A 100
Accrued Expenses 2,000
Current Assets 12,500
Current Liabilities 7,250
```
Which of the following is the company’s adjusted working capital to sales ratio?
8.47%
27
Sabre Manufacturing produces sheet components used in the production of washing machines and dryers. Revenues are $72MM. The following are highlights from the company’s balance sheet (in 000’s).
Cash 400 Short Term Debt 1,000
Accts Rec 5,000 CMLTD 250
Inventory 7,000 Accts Payable 4,000
Other C/A 100 Accrued Expenses 2,000
Current Assets 12,500 Current Liabilities 7,250
5) Which of the following is the company’s adjusted working capital?
6,100
28
Clearview Contacts, a distributor of contact lenses to optometric practices, is requesting a line of credit to support growing accounts receivable and inventory. Which of the following is the most appropriate facility?
Revolving line of credit with a borrowing base formula
29
Pro Paving is an asphalt contractor specializing in driveways and parking lots. The company has a $1MM line of credit with the bank. In June, the company purchased $750M piece of equipment with cash. At FYE December, the company found it could not retire the line of credit in full as it had done historically. Which of the following is the most likely reason the company couldn't clean up its line?
Cash from the line of credit was used to finance the equipment purchase.
30
Pawley's Hammocks is a rope, hammocks and outdoor chair manufacturer and is owned by Jeff Tybor. The company has revenues of $3MM. Pawley's has requested a seasonal line of credit from your bank. If the purpose of the loan is to finance the seasonal assets of the company, which of the following is the banks' PSR?
Conversion of trading assets
31
Pawley's Hammocks is a rope, hammocks and outdoor chair manufacturer and is owned by Jeff Tybor. The company has revenues of $3MM. Pawley's has requested a seasonal line of credit from your bank. Which of the following forms of support will you most likely require?
An unlimited personal guarantee from the owner
32
Ski Valley is a ski resort in the northeast. The company is requesting a line of credit from Your Bank to finance its working capital needs. Which of the following is the greatest risk of repayment?
The occurrence of the season
33
Ski Valley is a ski resort in the northeast. The company is requesting a line of credit from Your Bank to finance its working capital needs. Which of the following is the most important financial document needed to structure the loan?
Monthly cash budget
34
Clare's Costumes is the manuf. of costumes, primarily used for Halloween and theatre. The company's working capital cycle is highly seasonal with 75% of the revenues occuring during Sept to Nov. Your bank is preparing reporting covenants for the company's seasonal line of credit. Which of the following is the appropriate frequency for the loan covenant monitoring?
Quarterly.
35
What is UCA?
Uniform Credit Analysis
| Income Stmt sources/uses compared to B/S sources/uses. Match to the change in cash
36
What is accrual accounting?
Accrual - recognizes revenue earned and expenses incurred with accural adjustments regardless of CASH.
C/F should be calculated from accrual based f/s in order to measure actual sources and uses of funds.
```
Sources:
+ Revenue
+ Decrease in Asset
+ Increase in Liabilities
+ Increase in NW
```
Uses:
- Expenses
- Increase in assets
- Decrease in Liabilities
- Decrease in NW
37
What are the 4 steps to convert C/F?
1) Delete all non-cash entries from I/S
2) Modify all I/S accounts by YOY changes and related B/S items
3) Include spending not present in I/S (ie. CAPEX, Principal payments, Dividends)
4) Seperate internal and external sources of cash
38
What are the 3 categories of C/F?
1) Operating
2) Investing
3) Financing
39
Which statements do you need to determine C/F?
1) The Income Statement
2) The beginning and ending Balance Sheets for a period.
Cash repays debt.
40
Which type of method of c/f analysis would a short term lender usually prefer?
Short term lender = Direct Method
Long term lender = Indirect Method (though LT lenders usually prefer the direct method)
SFAS 95 allows either method. The primary purpose is to provide managers, investors, lenders and other interested parties with additional info regarding the health of the company.
41
What are the 2 types of CAPEX?
How is CAPEX calculated?
1) Maintenance (needs)
2) Discretionary (wants)
To calculate CAPEX: Look at the change in Gross Fixed Assets Y-O-Y OR add annual depreciation to the change in Net Fixed Assets from one year to the next.
42
What are the characteristics of Direct Cash Flow?
Direct C/F is known as the "top down" approach.
1) Starts with the 'top line' of the Income Statement (Net Sales)
2) Methodically adjusts the corresponding B/S accounts ("buddy accounts") to highligh which changes in W/C assets are affecting the c/f generated from operations.
3) Breaks out Interest Expense
4) Breaks out CPLTD
5) Does Not include Net Income (it is buried within) (as a result, it is harder to determine the sustainable profitability and long-term debt service capacity of the customer).
43
What are the characteristics of Indirect Cash Flow?
Indirect C/F is known as the "Bottom up" approach.
1) Starts with the 'Bottom' line on the Income Statement (Net Income)
2) Interest Expenses is already included in N/I. (It's hard to determine how comfortably a co can pay its Interest Expense).
3) Combines CPLTD with other changes in long-term debt to arrive a a "net" number for an increase or decrease in long-term debt. (Not easily determined how maturing LTD has been financed, either from new LTD or from operating C/F).
44
What are the 4 questions to ask regarding C/F and SFAS 95?
1) Is C/F Operations sufficient to pay Interest on all debt?
2) Is C/F Operation sufficient to repay scheduled maturities of LTD?
3) What are the co's financing requirements after CAPEX & other LT investments?
4) How has the co financed its activities? ie. through additional debt or equity, or draw-down of cash balances?
45
What is Net Cash After Operations (NCAO) tell you?
Amount available under Direct C/F Statement to service Interest on Bank Debt and Dividends
46
Which C/F method is generally provided in the auditor's financial reports and is self-explanatory?
Indirect C/F Method (RMA preferred)
47
Define Cash from Sales.
That portion of the present year's sales collected in the present year, plus any amounts from the previous years' sales collected during the present year.
48
Define Cash after Debt Amortization (CADA)
Computed by subtracting CPLTD o/s at the end of the previous year from net cash income. A positive # could mean that the co has been able to generate sufficient cash from its internal operations to meet all of its current obligations including interest & principal payments. A negative # could mean a co has to use external sources to repay debt or purchase CAPEX.
49
Define Financing Surplus or Requirements
Computed by subtracting fixed-asset purchases and expenditures for LT investments from CADA. This measures either the magnitude of external financing needed or the cash generated in excess of all needs of the business.
50
Define Net Cash Income
Computed by deducting financing costs (interest, dividends or withdrawals) from NCAO.
51
What is the purpose of analyzing cash flows?
1) to adjust revenues and expenses based on changes in their 'buddy accounts' on the B/S to determine their effect on cash flow
2) to eliminate non-cash expenses, such as deprec. and amort. from operating activities in determining c/f operations
3) to combine deprec. and amort. with changes in non-current assets and analyze effect on investing activities
4) to analyze changes in short & long-term debt and paid-in equity to determine their effect on financing activities.
52
Cash flow quality depends on the source and repeatability of the c/f. Important sources include:
1) those that are sustainable and reasonably predictable over 3-5 years
2) those that increase your margin of protection and indicate your customer's economic viability.
53
What are 3 Desirable Sources of Cash Flow (in order - most to least)?
1) Most - authentic and repeatable revenues and related non-cash expenses
2) OK - improvements in asset efficiency and proceeds of additional equity
3) Least - Additional debt or sale of assets
54
To analyze the demands of c/f, you should consider what?
1) Look at the c/f stmt and identify negative flows w/in each category
2) consider whether each negative c/f is a one-time, irregular event or will be recurring
3) consider if the amount of neg c/f was typical or it is unusually low or high
4) was the negative c/f within the control of mgmt?
5) compare historical demands with historical sources and expected future demands with expected future sources.
55
What are the 2 types of Operating Cash Flow?
1) C/F from Earnings is dependent on business fundamentals (positive operating cash flow can be attributed to strong profit margins). ie. sales growth, GPM, SG&A (% of sales), OPM, NPM
2) Swings in cash cycles - changes in swing factors reflect a company's abilty to manage its working capital assets. ie. A/R, A/P, or Inv turnover (in Days)
Whenever a combination of fundamentals and swing factors produce positive operating cash flow, there is an added margin of protection.
Make sure to analyze what uses of funds were financed by which sources of funds. Debt should be repaid through operating c/f's instead of additional debt or disposal of assets (especially operating assets). Key - look at magnitude of misc. income/(expense) - reflects non-operating c/f and is suspect in terms of sustainability.
56
What do Investing Cash Flows tell you?
C/F from investment activities (buying/selling plant or equipment, rental properties, stock in affiliates or subsidiaries). Changes in marketable securities are also classified as an investment provided they are considered Long Term instead of short term/cash.
Most co's investing activities will be negative until they enter a declining stage in their life cycle (ie. they reinvest less than they dispose). If negative, ask questions regarding future requirements. If positive, determine if one-time or recurring.
57
What do Financing Cash Flow tell you?
Financing activities = external sources of debt and equity.
- Short term or long term debt/note
- Stock certificates
The Direct method looks at changes in STD, LTD and Equity less CPLTD
The Indirect method 1st) combines new borrowing and repayments of STD and discloses net change, 2nd) combines that number with seperate figures for advances of LTD, repayments of LTD, and increases/decreases in NW (other than from profits or losses).
58
What are two ratios that evaluate C/F?
1) Cash Margin Ratio (Direct C/F)
Cash Gross Profit / Net Cash from Sales
The result is an indication of the % of each sales dollar that remains as cash after payment of all production or acquistion costs
2) Cash Coverage Ratio
under (Indirect Method)
Net Income + Depreciation + Amortization / CPLTD
This ratio has several limitations because:
a) It implies that all net income has equal potential
b) Does not account for major demands on c/f such as: Dividends & Working Capital changes because of sales growth or declining efficiency
c) it implies that loan repayment will have a 1st claim on c/f
Under (Direct Method) = Net Cash After Operations / Financing Costs + CPLTD
A ratio greater than 1:1 indicates no reliance on external financing to make the required payments. A ratio less than 1:1 indicates the co must raise external financing elsewhere
59
What are business fundamentals and swing factors sometimes known as?
"Cash Flow Drivers"
60
What are the 4 Business Fundamental ratios that we use to evaluate the company's key profitability components? *Cash flow Drivers
1) Sales Growth = (Sales Yr 2 - Sales Yr 1/Sales Yr 1) x 100%
2) Gross Profit Margin = Gross Profit/Net Sales x 100%
3) Operating Expense Percentage = Operating Expense / Net Sales x 100%
4) Operating Profit Margin = Operating Income / Net Sales x 100%.
61
What are the 3 Swing Factor turnover ratios that relate to the company's efficiency in managing its working capital assets? * Cash Flow Drivers
1) A/R Days Outstanding = A/R x 365 / Net Sales
2) Inventory Days Turnover = Inventory x 365 / COGS (including Depreciation)
3) A/P Days Turnover = A/P x 365 / COGS (excluding Depreciation)
62
What is the purpose of a C/F projection?
to determine whether your customer can repay your bank's debt based on reasonable estimates about the co's future operating strategy and managment's ability to implement it.
- Quantitative assesment of the future financial performance and financing needs of a co.
- Forecast of the co's ability to repay debt from its internally-generated cash
- Test of the vulnerability of a co to possible risks that may affect its repayment capacity.
63
What are 4 key reference points that are used in building projections?
1) Past operating results of a co (historical data)
2) Objectives and goals of a co for the future defined by mgmt and outlined in a business plan (subjective)
3) Likely impact of economic, competitive, and regulatory factors (subjective)
4) Supplemental action plans and alternatives available to help mgmt meet performance projections. Economic reports, analyses, forecasts. (subjective)
64
What is the purpose and function of a sensitivity analysis?
- Identify and access key/critical financial variables - when changed (positively or negatively) affect the future financial performance of a co and its ability to service debt
- Identify what would cause the change in these critical variables (external factors, mgmt actions, etc)
- Determine the amt of change in the drivers that can occur w/o materially affecting the co's ability to service the debt
65
What are the primary reason for a thorough sensitivity analysis?
- The analysis enables you to determine whether your co can repay its debt in less favorable busin/econ circumstances
- Whether the amt of financing requested is sufficient given all the demands on the co's c/f, particulary if there are material adverse changes in some underlying assumptions
- it indicates whether you have identified all of the key areas in the co's operation and financial condition that need to be monitored
- the most reasonable loan structure
- all possible developments that might relate to debt repayment have been addressed.
It is how you covenant the loan.
66
What is the best collateral in a liquidation scenario?
Quick turnover to cash:
- A/R
- Inventory
- Real Property
67
Evaluating collateral depends on two comprehensive areas...
1) Quality (value,how easily converted into cash)
| 2) Verifiabilty (accuracy of assessment, ability to test borrower's representations)
68
What are the two major considerations in determining the value of A/R?
1) Gross Dollar Amount of Receivables Outstanding
2) the Intrinsic Value of the receivables reported on the borrower's B/S (considers the overall collectibilty of A/R influenced by 1) Acct Customers 2) Credit Practices 3) Accuracy (Dilution - typical causes of dilution are Allowances/Discounts/Co-op Advertising; Returns; Bad debts/Write-offs; Contra Accounts)
69
What is the objective of a Cash Accounts Exam?
To determine if cash is being properly received and accounted for and disbursements properly documented. It would follow a transaction from sale/receivable to collection if in addition to an A/R Exam.
a) Verify deposit activity
b) Identify unusual disbursements
c) Investigate Suspicious Transactions
70
What is the objective of a A/R Exam?
```
To determine if the receivables are fairly stated and if they are valid and collectible.
# of areas of loss or exposure include:
- Bill and Hold.
- Prebill
- Partial Shipments
- Prepayments
- Dilution
- Poor credit quality
- Interco receivables
- Fictitious Receivables
```
Typical exam procedures include: Reconciling and Verifying the A/R Aging., Verify Shipment of Goods, Review the timeliness of payment and Credit Memo Posting, Identify Customer Concentrations, Review Credit Approval and Collection Procedures, Review Mgmt Info Systems Adequacy
71
What are key consideration to taking Inventory as Collateral?
Contents (Raw, Work-in-process, Finished, etc), Costings/Acct Methods (FIFO, LIFO), Physical Condition, Marketability (Liquidation value), Verifiability
Finished goods tend to hold the most value
Raw materials hold value
Work-in-Process values may be difficult to determine
72
What is the objective of an Inventory Exam?
To determine if the borrower's representation of inventory is accurate and to acceess the adequacy of the inventory as collateral for the co's borrowings.
of areas subject to loss or exposure:
- Theft
- Component Manipulation
- Overstatment of Quantity or Value
- Impaired Marketability
Typical exam procedures include:
Analyze Components; Test COGS; Confirm Valuation; Assess Marketability; Validate Quantity; Eval Physical Condition; Identify Obsolescence; Identify Ineligibles; Review MIS Adequacy
73
What is the objective of an A/P Exam?
To verify that all trade creditors and taxing authorities are being paid as required. Analysis of payables practices show the effective leverage of inventory. Verification of tax payments is important as liens for unpaid taxes may have precedence over secured creditor liens.
Typical exam procedures include:
- Review the A/P Aging
- Identify Payables Concentrations
- Identify Contra Accounts
- Review Payment Terms
- Verify Tax Payments
74
Characteristics of taking Plant/Equipment as Collateral
UCC Searches must be ordered in All Locations in all states in which financing statements are required at the time the loan is made.
*Verify adequate insurance is in place & bank is names as Loss Payee
Ask questions regarding location, loan/lease, lease terms/options, security interest, environmental conditions, appraisal, etc.
75
What is an appraisal?
An estimate of value of real property as of a defined point in time, based on current market conditions, characteristics of a particular neighborhood, current market rental rates and operating expenes, value of land and any improvements.
76
A Company’s cash cycle is measured by?
Days’ sales outstanding in A/R + Days’ cost of goods sold in inventory – Days’ purchases outstanding in A/P
77
If a company has days’ sales outstanding in accounts receivable of 45 day, COGS in inventory of 123 days and days’ COGS in accounts payable of 36, what is the length of the cash conversion cycle?
132 days
| Hint: A/R + Inv – A/P
78
All of the following factors may lengthen a company’s cash conversion cycle EXCEPT:
a. An increase in fixed asset spending to support long-term sales growth
b. An increase in inventory to stock an additional warehouse
c. A decrease in accounts payable because suppliers tightened payment terms
d. An increase in receivables after extending longer credit terms to customers
Answer: A
79
Which of the following businesses would typically have the shortest cash cycle?
A fast food restaurant
80
All of the following will typically occur in a company’s cash or asset conversion cycle EXCEPT:
a. Fixed assets to support the production of inventory are purchased
b. Cash is invested in the production of inventory
c. Trade credit reduces case required to support inventory
d. Inventory is converted into receivables as sales occur
Answer: A
81
Cash cycle analysis can help identify which of the following reasons a company has improved its loan repayment ability?
I. A reduction of days’ sales outstanding in accounts receivable after a company improved its collection procedures
II. Consistent growth in sales
III. A reduction in receivables and inventory at the company’s seasonal low point
IV. A Company’s ability to negotiate extended terms with suppliers
Answer: I, III & IV
82
Which of the following determine the length of a company’s operating cycle?
I. Time it takes to produce and sell inventory
II. Time it takes to pay trade creditors
III. Time it takes to pay employees
IV. Time it takes to bill and collect receivables
Answer: I, II & IV
83
Which of the following are the most likely reasons a lender may require a company to submit interim financial statements?
I. To learn if there is any variation in the company’s sales throughout the year
II. To learn if the company has taken any inventory write-downs
III. To verify the company is abiding by its financial covenants
IV. To verify satisfactory financial performance since the last financial statement
Answer: I, II & IV
84
Which of the following characteristics generally are present in a company that is seasonal?
I. Inventory will increase in anticipation of the seasonal peak
II. The need for credit will be lowest during the high point in the operating cycle
III. Receivables will increase after the increase in inventories
IV. Fixed asset spending will be highest at the seasonal peak
Answer: I & III
85
A cash budget will reveal all of the following information about a company EXCEPT:
a. The timing of receipts and disbursements
b. The amount of net profit budgeted
c. The timing of cash shortfalls
d. The amount of potential borrowings required
Answer: B
86
It is important to distinguish between seasonal and base-level assets for which of the following reasons?
I. To identify the portion of base-level assets that can be reduced to repay short term debt
II. To identify the amount of seasonal assets that are supported by owner’s equity
III. To identify the amount of operating cash flow needed to reduce debt supporting base-level assets
IV. To understand what amount of short-term debt is appropriate to support seasonal assets
Answer: III & IV
87
Sources of repayment for a loan include all of the following EXCEPT:
a. Sale of older equipment
b. Purchase of treasury stock
c. Decline in sales
d. Lower inventory levels
Answer B
88
Using Cost of Goods Sold when determining the average time it takes a company to pay its trade creditors is appropriate for all of the following types of businesses EXCEPT:
a. A beverage distributor
b. A hardware store
c. A custom furniture maker
d. An auto parts wholesaler
Answer: C
89
Cash flow drivers in a business include all of the following EXCEPT:
a. Rate of sales growth
b. Number of times inventory turns in one year
c. Amount of funds committed to investments
d. Terms of payment from trade creditors
Answer: C
90
Which of the following borrowing causes would be seen as presenting the least risk to a lender?
A seasonal increase in accounts receivable
91
A company makes a strategic decision to increase sales by offering extended terms to customers, expecting its average collection period to grow permanently from 30 to 45 days. A loan made to finance the additional working capital could be repaid from all of the following sources EXCEPT:
a. Contribution of additional equity by the owners
b. Proceeds from the sale of long-term investments
c. Collection of receivables on their due dates
d. Receipt of customer deposits upon placement of orders
Answer: C
92
A company has paid dividends in excess of its reported profits for the past two years and requests a term loan from its bank. Which of the following company attributes are most important for the bank to analyze?
I. The company’s ability to efficiently manage the collection of its receivables
II. The value of assets available as collateral
III. The company’s ability to stretch its accounts receivable
IV. The amount of leverage before considering a new term loan
Answer: I, II, III & IV
93
Which of the following will generally lead to a need to borrow?
I. Previously unissued stock is sold
II. Sales of a key product enter the growth stage
III. A just-in-time system for ordering inventory is implemented
IV. Trade suppliers begin offering discounts for faster payments
II. Sales of a key product enter the growth stage
IV. Trade suppliers begin offering discounts for faster payments
Answer: II & IV
94
8) A company has sales of $5,840,000 and cost of goods sold of $4,745,000. Which of the following current asset changes will occur it the company collects receivables four days faster while taking seven days longer to sell inventory?
A net increase in current assets of $27,000
HINT:
95
A company’s sales grow from $2,000,000 in Year I to $2,460,000 in Year 2 while its gross profit margin remains unchanged at 35%. Pricing does not change. The company’s receivables increase from $181,000 to $209,000 and its inventory increases from $128,000 to $166,000. Which of the following statements is (are) accurate?
I. Receivables grew in Year 2 as a result of higher sales and slower collections
II. Inventory grew at the same rate as sales growth in Year 2
III. Receivables were collected more quickly in Year 2
IV. Inventory turned more slowly in Year 2
III. Receivables were collected more quickly in Year 2
| IV. Inventory turned more slowly in Year 2
96
Without the cash flow statement, it's hard to determine ?
Whether accrual profits in a year actually translated into cash for debt repayment, or whether sales growth or declining asset efficiency diverted the cash for other uses.
97
UCA stands for ?
Uniform Credit Analysis
98
What are the 3 types of Cash Flow Statements?
SFAS 95 Direct
UCA Direct
SFAS 95 Indirect
99
Describe the principal difference in how the SFAS Direct, Indirect and UCA Direct formats present information about cash paid for interest and taxes?
SFAS Direct and SFAS Indirect do not break out cash paid for interest and taxes.
Only UCA Direct does.
100
Which format generally provides the most info about a bank's position relative to other claims on a company's cash flow?
UCA Direct
101
Describe similarities in how the three cash flow formats help interpret a company's cash flow. At least 3 characteristics of each.
UCA Direct & SFAS Indirect:
1) Both measure the cash impact of changes in the Balance Sheet
2) Both compensate for the disadvantage of accrual accounting
3)Separate C/F in a company's operating, investing and financing activities
4) Both separate internal from external sources and uses of cash flow
5) Both reconcile the net result of operating and investing c/f to the YOY change in cash
UCA Direct & SFAS Direct:
1) Both compensate for the disadvantage of accrual accounting
2)Separate C/F in a company's operating, investing and financing activities
3) Both separate internal from external sources and uses of cash flow
4) Both reconcile the net result of operating and investing c/f to the YOY change in cash
5) Treats the current year's loan principal reduction in a section separate from other financing cash flows. Deducts the current year's principal earlier in c/f.
102
ILS amortized a total of $2,171,000 of long term debt in X4. Where is the cash outflow for these payments reflected in the UCA direct cash flow statement? Where is this reflected on the SFAS 95 c/f stmts?
UCA - Interest Expense & CPLTD seperately after it calulates Cash from Operations
SFAS - Net Cash Provided by Financing Activities OR Net Cash Provided by Financing
103
Which section of the C/F statement includes the cash flow effect of changes in the company's cash cycle?
Operating Cash Flow
104
Why is it important to understand exactly how a cash flow statement adjusts income statement measure?
It enables you to identify reasons for the changes in cash from the prior year.
Each of the three c/f formats recognize that accrual measures of revenue, expense and profit obscure the company's actual cash receipts and outflows.
105
What is the definition of accrual accounting?
Recognizes revenue from a sale when the sale has been made and the company is entitled to the proceeds.
Accrual accounting matches the expense to the period in which it helped produce the sale.
We cannot rely on the I/S to tell us how much the company retained from a sale.
All 3 statements of c/f undo accrual accounting.
106
On a direct cash flow statement, where would you find the amount of cash available to service interest on bank debt?
Net Cash After Operations
107
Cash flow quality depends on?
Sustainable and predictable c/f over a 3-5 year period and those that increase a margin of protection (repeatable) and indicate a customer's economic viability.
108
What is the Cash Margin Ratio (on a direct statement)?
Direct:
Cash Gross Profit / Net Cash from Sales = % of each sales dollar that remains as cash after payment of all production (manuf) or acquisition (wholesaler/retailer) costs.
109
What is the Cash Coverage Ratio (on an indirect statement)? What are its limitations?
Indirect:
Net Income + Depreciation + Amortization / CPLTD. This ratio has severe implications because it implies that all net income has equal potential, does not account for major c/f demands like dividends and working capital changes becasue of sales growth and declining efficiency, and it implies that loan repayment will have the first claim on c/f.
Direct:
Net Cash After Operations / Financing Costs + CPLTD = if the ratio is greater than 1:1, it indicates no reliance on external financing to make the required payments. If less than 1:1, then external financing must be raised elsewhere.
110
What are the benefits of accrual accounting to lenders? What are the drawbacks?
1) superior presentation of a value of a company's assets, the extent of its liabilties, and the amounts of its earnings
2) provide a more accurate allocation of sales and expenses among accounting periods
One major drawback is that it can mislead about the borrower's ability to repay debt. Cash tied up in receivables, inventory, prepaid advertising, buildings, equipment or officer loans is NOT available to repay bank debt.
111
How do you convert an accrual based statement to a cash-basis (Direct)?
1) Reverse all non-cash entries (depreciation)
2) Modify items in the operating stmt by changes in any related balance sheet entries (Year-end receivables must be deducted from sales and A/R from prior year must be added)
3) Recognize certain transactions that do not appear on a standard accrual I/S but that are essential to the company's viability (ie. Capital expenditures, Term debt payments, Dividends)
4) Distinguish btwn internally or externally gnerated cash
5) Realize that internally generated c/f may result in cash surplus or requirement.
112
Which cash transactions are found on the UCA Direct C/F statement but are not found on the Income Statement?
Capital Expenditures, Term Debt Payments & Dividends
113
What is the 1st step in creating a UCA Direct C/F Statement?
Cash from Sales - convert accural sales to a cash basis by adjusting accrual sales by the amount of the YOY change in A/R.
An increase in receivables absorbs cash (used) and represents cash a co has to collect. A decrease in receivables releases cash (source).
114
What is the 2nd step in constructing a UCA Direct C/F Statement?
Calculate Cash Production Costs (same as accrual stmts COGS)
3 ways modified:
1) Remove non-cash expenses included in COGS (ie. Depreciation)
2) Adjust for YOY changes in B/S Inventory
3) Adjust for YOY changes in B/S Accounts Payable
Inventory and A/P reflect movements of cash that are part of the production process before sale.
If Cash Production Costs are less than accrual COGS by $46M, the difference can be explained by $107M noncash expense in COGS (-) $80M increase in inventory (+) $19M increase in payables
115
What is the 3rd step in constructing a UCA Direct C/F Statement?
Calculate Gross Cash Profit by subtracting Cash Production Costs from Cash from Sales.
This amount represents the cash remaining after transaction completion (manuf at one price and sale at a higher price).
Gross Cash Margin = Gross Cash Profit / Net Sales. This tells you how much each sales dollar remains in cash after payment for the goods that were sold.
116
What is the 5th step in constructing a UCA Direct C/F Statement?
Net Cash After Operations addresses 1) misc income/expenses (all minor or nonrecurring asset, liability, income, or expense items not addressed elsewhere in the cf statement 2) income taxes paid
A tax provision (IS) is a cash out. A tax benefit (due to a loss) is a source of cash. An increase in an asset tax acct (tax refund receivables) is a source of cash. An increase in a liability tax acct (current tax payable or deferred tax payable) is a source of cash. A decrease in a tax liability acct is a use of cash.
Subtract misc items or taxes paid from Cash after Operations to get to Net Cash After Operations
117
What is the 4th step in constructing a UCA Direct C/F Statement?
Calculate Cash After Operations by 1st calculating Cash Operating Expenses (adjust accrual operating expenses for noncash items and changes in B/S accts that directly apply to day-to-day operations including accrued operating expenses and prepaid operating expenses)
118
What is the 6th step in constructing a UCA Direct C/F Statement?
Net Cash Income = Net Cash After Operations - financing costs ie. interest expense & dividends (also modified by changes in related BS accts, accrued interest or dividends payable). A prior yr's liability paid in the current yr is a use of cash. A current yr's liability acct is a source of cash.
If Net Cash Income is positive, the co funded all of its working capital needs and interest expense from operating cash flow
If Net Cash Income was negative, then non-operating sources of funds were needed to cover these requirements.
119
What is the 7th step in constructing a UCA Direct C/F Statement?
Cash after Debt Amortization = Net Cash Income - CPLTD
Negative debt amort = the co's inability to meet debt service from internally generated funds, which creates a need for external sources to make up the difference.
The Cash Coverage Ratio is the measure of a firms ability to service it's debt with internally generated cf.
Calculated by: Net Cash After Ops / Financing Costs (interest & dividends) + CPLTD. A ratio less than 1:1 indicates a co must borrow funds to meet all financial obligations.
120
What is the 8th step in constructing a UCA Direct C/F Statement?
Financing surplus (requirement) which looks at Capital Expenditures (including Intangibles) and Long term Investments, both of which are considered to be a discretionary use of corp funds and are not likely to return to cash in the near future.
A financing surplus represents cash generated from internal operations that was not needed to pay interest or principal or capital expenditures.
121
What are 3 external sources of cash available to any company to meet a financing requirement?
1) Equity infusion (All Profits and Dividends in the current yr are excluded as they are already included in the cf stmt) - The Only Capital Accts included are changes in common stock, preferred stock, treasury stock, and Paid-In-Equity
Treasury stock is issued but not o/s.
Paid in Equity is capital received from investors in exchange for stock, surplus of recapitalization
2) Increased borrowings under a credit line
3) Additional long term debt - make sure to subtract the CPLTD already captured by the cf stmt
122
To reconcile differences on the UCA cash flow stmt, you should:
Check the difference between calculated and actual changes in cash. Divide the difference by 2 to see if it could reveal an entry with an improper sign (+/-)
Check the misc section to see you have accounted for every income statement and bs entry.
Check the capital expenditures and changes in LTD sections for errors
Check to see if the change in retained earnings section is the result of erroneously added profit or loss.
123
What are some analytical traps of the direct format?
The direct format attempts to combine sources and uses of cash from both the income stmt and BS in a single CF stmt. There is no order of prioritization, which can lead to incorrect conclusions regarding the true-cash generating ability of the co.
124
What is the analytical trap of the Indirect stmt?
The indirect stmt makes the assumption that EBIDA cf is dedicated first to the repayment of Current maturities, interest expense and dividends.
Regardless of the format, the goal is to get behind the numbers and determine if the co's matching of sources and uses reflects a healthy financial condition and good financial mgmt
125
What are the 4 questions of analysis on the UCA direct cf stmt?
Has the company paid its interest from internally generated cash flow?
Has the company paid its principal payments from internally generated cash flow?
How much cash did the co require?
How has the company financed itself?
These Q's promote the Top Down approach to analyzing cash flow so we need to be particularly careful about not making false conclusions.
126
Where would we find if:
The company paid its interest from internally generated cash flow?
Made its principal payments from internally generated cash flow?
How much cash did the co require?
How did the company finance itself?
The company paid its interest from internally generated cash flow? Net Cash Income
Made its principal payments from internally generated cash flow? Cash After Debt Amortization
How much cash did the co require? Financing Surplus (Requirement)
How did the company finance itself? Meeting a financing requirement and disposing a financing surplus
127
A company with a contribution margin that is increasing over time should exhibit which of the following?
a. A break-even point that is increasing over time
b. A break-even point that is decreasing over time
c. Variable expenses that are growing faster than sales
d. Fixed expenses that are growing faster than sales
The answer is B
128
Which of the following is usually the best indicator of a company's profitability?
a The gross profit margin
b. The operating expense ratio
c. The operating profit margin
d. The pre-tax profit margin
The answer is C
129
When analyzing comparative statements, all of the following steps will help ensure accounting is consistent EXCEPT:
a. Read the footnotes of statements being compared and note any accounting method
Differences
b. Make comparisons based on a large sample size to mute the effects of any accounting
differences
c. Remember to expect certain results based on accounting differences if statements cannot be adjusted
d. Use only statements where the accountant has expressed an unqualified opinion
The answer is D
Use only statements where the accountant has expressed an unqualified opinion
130
The operating profit margin measures profitability after all of the following expenses EXCEPT:
a. Cost of advertising
b. Cost of monies borrowed
c. Cost of officers’ life insurance premiums
d. Cost of sales tax
The Answer is B
Cost of monies borrowed
131
Which of the following calculations is used to measure the degree of operating leverage?
a. (Sales less variable expenses)/sales
b. (Sales less fixed expenses)/sales
c. Fixed expenses/variable expenses
d. (Sales less variable expenses)/(sales less total expenses
The Answer is D
132
Which of the following are requirements for inclusion in the RMA Annual Statement Studies?
I. Minimum of 10 companies in sample for asset and sales-size comparisons
II. Financial statements prepared on an audited or reviewed basis
III. Companies with sales of at least $100M for sales size comparison
IV. Companies with assets of less than $250MM for asset size comparison
a. I & II
b. I & IV
c. II & III
d. I, II & IV
The Answer is B
Minimum of 10 companies in sample for asset and sales-size comparisons and Companies with assets of less than $250MM for asset size comparison
133
All of the following will directly cause a company’s gross profit margin to change EXCEPT:
a. An increase in the number of units sold
b. A decrease in the cost of each unit sold
c. A decrease in the price of each unit sold
d. An increase in the cost of each unit sold
The Answer is A
An increase in the number of units sold
134
What is a debit / credit on assets and liabilities?
Asset: Debit is a reduction in cash. A Credit is an increase in cash.
Liability: Debit is a increase in debt. A Credit is a reduction in debt.
134
Statements used for comparative purposes should meet all of the following criteria EXCEPT:
a. Statements should be for companies in similar types of businesses
b. Statements should demonstrate similar ownership structures
c. Statements should be for businesses of similar size
d. Statements should be drawn from approximately the same periods
.
The answer is B
Statements should demonstrate similar ownership structures
