NISM Certifications · NISM-Series-XV: Research Analyst · Company Analysis - Business and Governance
Which of the following is generally considered a sign of a company with weak earnings quality?
Rising reported profits accompanied by persistently weak operating cash flow and ballooning receivables signal weak earnings quality, since profits are not converting into cash and may reflect aggressive revenue recognition. Cash-backed profits, stable policies and clean audit opinions suggest the opposite.
- AOperating cash flow consistently tracks or exceeds reported net profit
- BReported profits rise steadily while operating cash flow stays persistently weak and receivables balloonCorrect
- CRevenue recognition policies remain unchanged year after year
- DThe auditor issues an unmodified opinion with no emphasis of matter
Explanation
When profits grow but cash flow from operations lags and receivables rise sharply, accounting profits are not converting to cash, which suggests aggressive revenue recognition or poor collections. The other options are indicators of good earnings quality.
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