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    Question

    ABC Ltd. reported net profits of ₹12 lakh, but their

    cash from operations was only ₹3 lakh. The company made large purchases of inventory and extended high credit to customers. Which aspect of the financial statements does this situation highlight and what should an analyst infer from it?
    A Profitability – indicates excellent cash flow Correct Answer Incorrect Answer
    B Liquidity – high working capital Correct Answer Incorrect Answer
    C Accrual Accounting – profits ≠ cash flows Correct Answer Incorrect Answer
    D Efficiency – better inventory turnover Correct Answer Incorrect Answer

    Solution

    Accrual accounting recognizes income and expenses when incurred, not when cash is received or paid. Hence, even if the profit is high, cash may be tied up in inventory or receivables, leading to low operating cash flow. This distinction is crucial in financial statement analysis.

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