CFA Level I · CFA Level I Exam · Analyzing Statements of Cash Flows II
An analyst reviewing a company's statement of cash flows under IFRS wants to judge the quality of its operating cash flow. Which of the following observations is the most likely indication of strong earnings quality?
Operating cash flow that consistently exceeds net income most likely indicates high earnings quality, because reported profits are supported by cash. Inventory reductions or rising receivables produce earnings or cash flows that are unsustainable or not yet collected, which weakens quality.
- AOperating cash flow consistently exceeds net incomeCorrect
- BOperating cash flow is positive only because of reductions in inventory
- CNet income growth is driven by rising accounts receivable
Explanation
Operating cash flow that consistently exceeds net income suggests earnings are backed by cash and are not driven by aggressive accruals. Cash flow from inventory liquidation is not sustainable, and growth driven by receivables means earnings are not yet converted to cash.
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