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NISM Certifications · NISM-Series-XV: Research Analyst · Company Analysis - Financial Analysis

A company's EBITDA rises while its reported net profit is stable, but cash flow from operations is consistently far below net profit. Which interpretation is most appropriate for an analyst?

Persistently low operating cash flow compared with net profit suggests weak earnings quality. Profits are being recognised on an accrual basis, for instance through growing receivables or inventory, without being converted into cash, so an analyst should investigate further.

  1. AEarnings quality may be weak, for example due to rising receivables or inventory build-upCorrect
  2. BEarnings quality is strong because profits are conservative
  3. CThe company must be repaying debt from operating cash flow
  4. DDepreciation has fallen sharply

Explanation

When operating cash flow persistently lags profit, the gap often reflects accrual items such as increasing receivables or inventory, which signals lower earnings quality. Conservative accounting would normally show cash flow near or above profit. Debt repayment belongs to financing cash flow, not operations.

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