CFA Level I · CFA Level I Exam · Analyzing Statements of Cash Flows II
A company's cash flow to net income ratio has fallen over three years while net income has risen steadily. This pattern most likely indicates that:
This pattern most likely signals weakening earnings quality. Net income is rising but converting into less operating cash, which often reflects growing receivables, inventory or aggressive accruals. It does not show more cash than profit or better capital expenditure coverage.
- Aearnings quality may be weakening because profits are converting less into cashCorrect
- Bthe company is generating more cash than accrual profit each year
- Coperating cash flow coverage of capital expenditures is improving
Explanation
A falling operating cash flow to net income ratio with rising income suggests a growing share of earnings is accruals, such as receivables or inventory build-up, signaling possible lower earnings quality. The other statements do not follow from the ratio.
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