CCA Cash Flow Analysis 2 — Questions and Answers
Question 1: When analyzing a borrower's cash flow statement, an increase in inventory is treated as:
- A source of cash in operating activities
- A use of cash in operating activities (Correct answer)
- A source of cash in investing activities
- A use of cash in financing activities
Correct answer: A use of cash in operating activities
Increases in inventory represent cash spent to build stock, reducing operating cash flow under the indirect method.
Question 2: The direct method of presenting operating cash flows differs from the indirect method primarily because the direct method:
- Starts with net income and adjusts for non-cash items
- Reports gross cash receipts and payments from operations (Correct answer)
- Only discloses investing and financing activities
- Excludes working capital changes
Correct answer: Reports gross cash receipts and payments from operations
The direct method lists actual cash received from customers and cash paid to suppliers, whereas the indirect method reconciles net income to operating cash flow.
Question 3: A company with stable profitability but rapidly increasing cash from financing activities warrants scrutiny because it may indicate:
- Strong organic growth funding operations
- Excessive reliance on external debt or equity to fund shortfalls (Correct answer)
- Conservative leverage management
- Superior working capital efficiency
Correct answer: Excessive reliance on external debt or equity to fund shortfalls
Heavy financing inflows suggest the company cannot self-fund operations, raising concerns about long-term debt sustainability.
Question 4: Which ratio uses cash flow from operations as the numerator to assess short-term liquidity?
- Current ratio
- Operating cash flow ratio (Correct answer)
- Quick ratio
- Cash conversion cycle
Correct answer: Operating cash flow ratio
The operating cash flow ratio (Operating CFO / Current Liabilities) measures how well current liabilities can be covered by cash generated from operations.
Question 5: In project finance credit analysis, which cash flow measure is typically used to evaluate a project's ability to repay debt?
- Earnings before interest and taxes (EBIT)
- Project free cash flow after debt service (Correct answer)
- Gross revenue projections
- Book value of project assets
Correct answer: Project free cash flow after debt service
Lenders evaluate project free cash flow after debt service to confirm sufficient residual cash remains following all principal and interest payments.
Question 6: A company's capital expenditure exceeds its depreciation consistently over several years. From a credit perspective, this most likely signals:
- Asset base shrinkage and declining capacity
- Growth investment requiring monitoring of free cash flow (Correct answer)
- Cosmetic earnings manipulation
- Reduced future maintenance needs
Correct answer: Growth investment requiring monitoring of free cash flow
Capex exceeding depreciation indicates net asset investment and growth, which is positive but may reduce free cash flow and increase borrowing needs.
Question 7: Which of the following adjustments is made to EBITDA to arrive at a more conservative 'adjusted cash flow' measure used in credit analysis?
- Adding back stock-based compensation
- Subtracting maintenance capital expenditures (Correct answer)
- Adding back one-time restructuring charges
- Including unrealized foreign exchange gains
Correct answer: Subtracting maintenance capital expenditures
Maintenance capex must be deducted from EBITDA because it represents a recurring cash cost needed to sustain earning capacity, not a discretionary expense.
CCA Cash Flow Analysis 2
When analyzing a borrower's cash flow statement, an increase in inventory is treated as: