CFA Level I · CFA Level I Exam · Financial Reporting Quality
Over three years, a company's revenue grew steadily, but its cash flow from operations fell sharply while net income rose and accounts receivable increased much faster than sales. This pattern most likely indicates:
The pattern most likely indicates possible aggressive revenue recognition. Earnings are rising while operating cash flow drops and receivables grow faster than sales, suggesting revenue is booked before cash is collected, so the analyst should investigate further.
- Aconservative revenue recognition with deferred income
- Bimproved working capital management through faster collections
- Cpossible aggressive revenue recognition that warrants further investigationCorrect
Explanation
Rising earnings with falling operating cash flow and receivables outpacing sales is a classic warning sign of premature or fictitious revenue recognition. Faster collections would shrink receivables and raise cash flow. Conservative recognition would depress earnings relative to cash, the opposite of this pattern.
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