Which of the following statements about operating income and operating cash flow are correct or incorrect?
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Statement #1: |
If operating income is growing faster than operating cash flow over the long-term, the firm may be recognizing revenue too soon or delaying the recognition of expense. |
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Statement #2: |
Operating cash flow exceeding operating income is sustainable over the long-term. |
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Statement #1 is correct. If operating income and operating cash flow are growing at different rates over the long-term, the firm may be engaging in earnings manipulation. Statement #2 is incorrect. Over the long-term, operating cash flow will eventually decline without the support of operating income.
Which of the following statements about operating income and operating cash flow is most accurate?
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When the growth rates of operating income and operating cash flow are stable over time, operating income is being confirmed by operating cash flow. Operating cash flow is more reliable than operating income. During growth, operating cash flow is usually lower than operating income as the firm uses cash to increase inventories and receivables.
Recently, Galaxy Corporation lowered its allowance for doubtful accounts by reducing bad debt expense from 2 percent of sales to 1 percent of sales. Ignoring taxes, what are the immediate effects on Galaxy’s operating income and operating cash flow?
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Operating income |
Operating cash flow |
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Lower bad debt expense will result in higher operating income. Operating cash flow is not affected until Galaxy actually collects the receivables.
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