- 1). Evaluate if the cash from operating activities is higher than net income. A company with high-quality earnings will have a higher amount of operating cash than net income. This implies that revenue amounts are converting into available cash. A company with a consistent source of operating cash has higher-quality revenues, more opportunities to grow or pay investor dividends, and a greater ability to meet its debt obligations. If cash from operating activities is negative, this a sign that revenues are not high enough to meet the operating needs of the company.
- 2). Evaluate the accounts that increased operating cash in the period. Examples of transactions that can increase operating cash are payments on accounts receivable, sales of inventory, and interest and dividends received. Evaluate these amounts over several periods and determine if they are increasing or decreasing. Identify recurring and nonrecurring cash inflows and their effect on operations. Compare the activity in this section with other similar companies and industry standards.
- 3). Evaluate the accounts that decreased operating cash in the period. Examples of transactions that can decrease operating cash are payments on accounts payable, purchases of inventory, interest and dividend payments, and income tax payments. Evaluate these amounts over several periods and determine if they are increasing or decreasing. Identify recurring and nonrecurring cash outflows and their effect on operations. Compare the activity in this section with other similar companies and industry standards.
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