ACCA Applied Knowledge · Financial Accounting · Analysis of financial statements
A bank is deciding whether to lend $2 million to Hartley Co. Which ratio would be MOST relevant to the bank in assessing the risk that Hartley Co may be unable to meet its interest payments?
Interest cover is the most relevant ratio, because it compares profit before interest and tax with finance costs and so shows how comfortably Hartley can meet interest payments. Earnings per share, gross margin and receivables days do not directly measure a lender's interest risk.
- AInterest coverCorrect
- BEarnings per share
- CGross profit margin
- DReceivables collection period
Explanation
Interest cover (profit before interest and tax divided by finance costs) directly shows how many times profit covers interest, which is the lender's concern. Earnings per share concerns shareholders, while gross margin and receivables days relate to trading performance and working capital.
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