G2 - Financial Analysis for Credit CH2 Efficiency & Liquidity

Efficiency & Liquidity

What is the asset turnover ratio?

Net Sales ÷ Total (Net) Assets. This shows revenue generated per £ of assets.

Why is asset turnover useful to a credit analyst?

Shows how efficiently assets generate revenue and supports repayment capacity.

State the formula for Working Capital

Current Assets ÷ Current Liabilities (often called Current Ratio).

How do you calculate Accounts Receivable Days?

(Accounts Receivable × Days in Period) ÷ Revenue.

How do you calculate Inventory Days?

(Inventory ÷ Cost of Sales) × Days in Period.

How do you calculate Accounts Payable Days?

(Accounts Payable ÷ Cost of Sales) × Days in Period.

What is the Working Capital Funding Gap formula?

Receivable Days + Inventory Days − Payable Days.

What does a larger funding gap mean?

More days the company is “out of money” and greater short-term financing need.

How does inventory turnover relate to inventory days?

Inventory turnover = COGS ÷ average inventory; Inventory days = 365 ÷ turnover.

Why remove inventory in the quick ratio?

Inventory is less liquid — quick ratio focuses on immediately convertible assets.

Quick ratio formula?

(Current Assets − Inventory) ÷ Current Liabilities.

What's the practical difference between current and quick ratios?

Quick ratio tests immediate liquidity without relying on selling inventory.

When structuring a loan, why match asset type to loan term?

To align cash outflows (repayments) with cash inflows generated by the asset — avoids maturity mismatch.

Give an example of a good match: asset vs loan type.

Financing inventory with a revolving line; financing real estate with a mortgage.

What does a current ratio of less than 1 typically indicate?

Potential short-term liquidity stress.

Name one limitation of the current ratio.

It’s a snapshot and ignores asset quality (e.g., slow receivables).

How do you convert a ratio analysis into practical lending insight?

Stress-test with proposed borrowing, include current portion of new debt in liabilities.

What is “working capital optimisation”?

Actions to reduce funding gap: faster collections, leaner inventory, extended payables.

How can you measure receivables quality?

Aging schedule and bad-debt history (% write-offs).

What is the effect of offering early payment discounts?

Accelerates collections but reduces gross revenue per sale. Demonstrates trade-off vs cash benefit.

Why is inventory classification important for liquidity analysis?

Some inventory (custom, aged) is illiquid and not easily converted to cash.

How should seasonal spikes be handled in liquidity analysis?

Model peak working capital needs and ensure credit lines cover seasonal troughs

What does a high asset turnover and low margin imply?

Commodity-like business: high volume, low margin.

What does low asset turnover and high margin imply?

Asset-light or premium product business with higher margins.

How does growth affect working capital needs?

Faster growth typically increases receivables and inventory, widening the funding gap.

How can receivable factoring affect liquidity?

Converts receivables into immediate cash (less fees), reducing funding gap.

Why do lenders stress-test liquidity ratios with new debt included?

To assess repayment capacity under the proposed capital structure.

What’s the impact of stretching payables too far?

Damaged supplier relationships, potential loss of discounts, supply risk.

How does e-invoicing improve working capital efficiency?

Faster invoice delivery and automated follow-ups accelerate collections.

What are “sweep” accounts and why use them?

Automatic consolidation of excess cash to central account for better liquidity management.

How does just-in-time inventory reduce working capital needs?

Lowers average inventory held, freeing up cash.

When is a higher current ratio acceptable?

In asset-heavy, slow-turnover industries where liquidity buffers are normal.

Which is more informative for acute liquidity: current or quick ratio?

Quick ratio.

How do you convert days ratios to balances in models?

Balance = (Days × flow metric) ÷ 365.

Name two leading indicators of working capital deterioration.

Rising DSO (days sales outstanding), increasing inventory days.

How can supplier financing (trade credit) be modeled?

As increased payable days or a supplier financing line in liabilities.

What is an example KPI to track inventory health?

% of inventory older than X days or turnover by SKU.

How to treat related-party payables in liquidity analysis?

Examine terms and legal enforceability; may be soft/non-commercial.

Why check off-balance-sheet items for liquidity risk?

Contingent liabilities or guarantees can suddenly require cash.

Quick one-line lender rule for liquidity?

Ensure operating cash flow or committed facilities can cover peak funding gap.