CFA Level II ExamFixed IncomeEasy
A credit analyst is assessing a company's credit risk by evaluating its financial statements. Which of the following financial ratios would be most indicative of a company's ability to meet its short-term obligations?
- AInterest Coverage Ratio.
- BCurrent Ratio.
- CReturn on Assets (ROA).
- DDebt-to-EBITDA.
Show answer & explanationAnswer & explanation
Correct answer: B. Current Ratio.
The Current Ratio (Current Assets / Current Liabilities) is a liquidity ratio that directly measures a company's ability to cover its short-term obligations with its short-term assets. The other ratios are more indicative of solvency or profitability.
Why the other options are wrong
- A. Incorrect. The Interest Coverage Ratio measures a company's ability to pay interest expenses, which is a solvency measure related to debt, but not specific to overall short-term obligations.
- C. Incorrect. Return on Assets (ROA) is a profitability ratio, indicating how efficiently a company uses its assets to generate earnings, not its ability to meet short-term obligations.
- D. Incorrect. Debt-to-EBITDA is a leverage ratio, indicating long-term solvency, not short-term liquidity.
Liquidity Ratios for Credit Analysis
Liquidity ratios measure a company's ability to meet its short-term financial obligations using its current assets.
- Current Ratio: Current Assets / Current Liabilities.
- Quick Ratio (Acid-Test Ratio): (Current Assets - Inventory) / Current Liabilities.
- Higher ratios generally indicate better short-term liquidity.
Memory trick: Liquidity 'flows' to cover 'short' needs.