What are the major differences between Operating income(Income statement) and Cash flow from operations(Cash flow statement)?
FSA level I stuff, I presume
Like CP said, it is part of L1 curriculum. A quick recap: 1. The first one which many of us miss is the Interest paid. Interest Paid is part of Operating Cash Flows but is NOT part of Operating Income. Operating Income is EBIT, that is, earnings before Interests paid and Taxes paid. 2. The second one is non-cash current assets and current liabilities. These are included in Operating Income but NOT included in Operating Cash Flows, as they are non-cash. For example, Credit Sales are included in calculation of Operating Income, but not in Operating Cash Flows. We will reduce respective Accounts Receivables from Operating Income to get our Operating Cash Flows. Similarly Credit Purchases will be part of Operating Income thru COGS, but they will not be part of Operating Cash Flows. We will increase Operating Income by respective Accounts Payables to get out Operating Cash Flows.
so which number is better from an analytical standpoint? Thanks for the clarification by the way.
From an analytical standpoint, both are important. 1. Operating Income is important, as it helps in a better FORECAST of value of Company’s business. 2. Operating Cash Flows are important, as it helps in a better assessment of CURRENT value of Company’s business. While both are important to us as Analysts, we should also analyze past deviations between these two figures. Lesser and more consistent deviation between these two is desired. If it is not so, we should reason out why it is not so. And if it cannot be explained, it becomes a case to be suspected for Earnings Manipulation.
Earnings are subject to accrual accounting events that require numerous estimates and judgements. As a result, earnings are more easily manipulated than cash flow. That is why as an analsyst we should always calculate Balance Sheet and Cash Flow accruals ratios. If a Company has a high percentage of accruals, you want to compare cash flow to its operating income. Your interest is in determining whether operating income is confirmed by cash flow.