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IAI Actuarial Core Principles · Business Finance · Interpreting company accounting information

A profitable manufacturing company reports strongly rising profit but its net cash from operating activities has fallen sharply for two years. Which is the most likely explanation from the accounts?

The most likely cause is that receivables and inventories are growing faster than sales, so profits are recognised but cash is tied up in working capital. Non-cash charges and longer payables would instead improve operating cash flow relative to profit.

  1. ADepreciation charge has increased significantly
  2. BReceivables and inventories have grown faster than salesCorrect
  3. CTrade payables have been stretched to longer payment periods
  4. DProfit includes a large non-cash impairment charge
  5. Interest paid has been reclassified to financing activities

Explanation

Growing receivables and inventories tie up cash, so profit rises without matching cash inflow. Higher depreciation, impairments and stretched payables would all raise or leave unchanged operating cash relative to profit. Reclassifying interest does not explain a sharp fall in genuine cash conversion.

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