Question

Why has cash flow from operations become increasingly important as an analytical tool?

1) Inflation has distorted the meaningfulness of net income.
2) Firms may have uncollected accounts receivable and unsalable inventory on the books.
3) High interest rates can put the cost of borrowing to cover short-term cash needs out of reach for many firms.
4) All of the above.

Answer 1

Cash flow from operations is crucial as inflation can distort net income, uncollected receivables and unsalable inventory may overstate earnings, and high-interest rates can make borrowing to cover cash needs less viable.

Step-by-step explanation:

The importance of cash flow from operations as an analytical tool has become more pronounced for several reasons. Firstly, inflation has the potential to distort the meaningfulness of net income figures by changing the value of money over time, which can affect the accurate representation of a company's profitability. Secondly, firms may display earnings through sales, yet they might have uncollected accounts receivable or unsalable inventory, which does not contribute to actual cash availability. Lastly, high-interest rates can limit a firm's ability to borrow affordably, making it challenging to cover short-term cash needs through external financing. Therefore, evaluating the cash generated from operations provides a clearer, more reliable indication of a company's financial health in the face of these complications.