Judge the quality of a company's cash flows
The idea
Cash flow quality is judged mainly through operating cash flow. It is high when operating cash flow is positive, derived from sustainable operations, broadly consistent with net income and not boosted by timing moves. Warning signs are stretching payables, selling or securitising receivables, cutting inventory unsustainably, or classifying operating outflows as investing, for example capitalising costs. Under IAS 7 (before IFRS 18), interest and dividends paid can be classified as operating or financing, and interest and dividends received as operating or investing, so comparability needs adjustment; US GAAP fixes interest paid and received in operating. The trap is treating a jump in operating cash flow as quality when it came from delaying supplier payments.
In the app: 2 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Evaluating Quality of Financial Reports
- Show how a conceptual framework is used to judge how reliable and useful a company's financial reporting is
- Explain problems that can undermine the quality of financial reports
- Explain the process for judging how good a company's financial reports are
- Judge how good a company's financial reports are
- Explain the signs that indicate earnings quality
- Explain what is meant by sustainable (persistent) earnings
- Explain why earnings revert to the mean and how accruals change how quickly they do so
- Judge the quality of a company's earnings
- Explain the signs that indicate balance sheet quality
- Judge the quality of a company's balance sheet
- Explain the signs that indicate cash flow quality
- Set out where information about risk can be found