Question

When Bank RI or any other bank assesses whether a business is creditworthy and capable of repaying a long- or short-term debt obligation, one of the first things they consider is the movement of money into and out of the firm, also known as

a.cash flow.

b.risk-return ratio.

c.sales revenue.

d.collateral.

Which of the following forms of debt financing is unlikely to be used by a firm the size of Moonworks?

a.Commercial paper

b.Promissory note

c.Loans secured by inventory

d.Trade credit

Answer 1

1) Option A - Cash Flow

Credit analysis is used by banks or lenders to gauge the financial strength of the company which includes ratio analysis and cash flow analysis also. The creditor is interested in how the firm generates cash and whether it will be able to cover the interest as well as principal payment in the future. A positive and stable operating cash flow is always considered better.

2) The background information about Moonworks is not mentioned here.

Generally, smaller or midsize firms lack the scale and do not require a large amount of money and so they use financing methods such as promissory note or loan against an asset. A promissory note is a written document in which terms and conditions are mentioned for loan repayment. The company can also secure financing against its assets such as account receivables or inventory. In another method, the company can seek trade credit whereby a supplier issues credit to the company and company buys material but pays after some specified period.

Commercial paper is odd in this category because it is issued by a large corporation or banks for short term financing or say less than a year. The commercial paper market is very large and tends to be more liquid.

Option A is correct.