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Subject 5. Cash Flow Quality PDF Download
Unlike net income, cash flow is much less likely to be manipulated by management's choice of accounting policies and estimates.

Classification Issues

For example, Under GAAP:

  • A company can choose to classify its investments as trading, available-for sale, or held-to-maturity. Investments classified as trading are reported in the operating section of the cash flow statement whereas available-for-sale and held-to-maturity investments are reported in the investing section.
  • Dividends and interest received from investments, whether classified as held to maturity, available for sale, or trading, are included in operating cash flow.
  • Accordingly, different companies may establish different boundaries for identical security transactions based on differences in management policies and intent.

Timing Issues

For example, a company can improve its OCF by simply delaying paying its payables.

Analysts should also look for omitted investing and financing activities because some cash flows are never reported in either the balance sheet or the cash flow statement, or they never appear in any financial statements at all. Operating leases is a good example. Analysts should pay attention to the growth of operating lease activity.

A truly sustainable relationship between earnings and operating cash flow requires that the two measures grow at comparable rates over the long term. A lasting discrepancy in their rates of growth should be investigated in order to gain an understanding of its causes and implications. For example, a continuing excess of earnings growth over the rate of growth in operating cash flow may indicate that earnings have been boosted by artificial means - earnings are at increased risk for decline.

User Contributed Comments 3

User Comment
allanzhu why is "II. May have at most two expected returns for each level of variance."
giroth Min-Var frontier is not the same as the efficient frontier. Min-Var frontier is the entire curve, and each point in the efficient frontier has a matching point (suboptimal) below it
alai2008 you can see it in the graph that is includen in the theory
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I am happy to say that I passed! Your study notes certainly helped prepare me for what was the most difficult exam I had ever taken.
Andrea Schildbach

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