Acconting/Cash Flows?

Question

Does anyone know how operating cash flows can serve as one indicator of earnings quality?

Answer 1

Operating cash flow is a purer indicator of the performance of a corporation. Take Enron for example. Using Mark-to-Market accounting they were booking revenues many years before such revenues were earned and delivered. Under their accrual method they reported large sales with minimal expense, thus lots of earnings. On their cash flow statement (which they stopped releasing with their earnings, and even swore at an analyst who asked them for one) they would show minimal cash from customers, resulting in almost no cash flow from operations. However, Enron would have shown strong performance in other parts of their CF statement, mostly due to constant borrowing from creditors. Another example is World Com who chose not to write off lots of A/R's. They too would report lots of low quality sales (if you consider a customer who never pays low quality). Under the IS they would show great earnings, but on their cash flow statement they would show minimal operating cash received due to poor collections. By observing the large mismatch between cash flow and net income you will quickly conclude something isn't right and earnings quality is not good.

Answer 2

cash and earnings are two separate issues.
the acid test may be relevant though ie ratio of cash and debtors to current liabilities; of this varies by industry type. but usually the higher the ratio the better.

Answer 3

hard aspect. research at yahoo. that might help!