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?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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