Question

All of the following are advantages of an increasing cash flow from operations except:

(a)A company is likely to pay its current bills with cash from operations not earnings.

(b)Large cash flows eliminate the need for borrowing.

(c) A company with cash is in a better position to fund growth.

(d) Earnings are viewed better if cash flows from operations closely match net income.

Answer 1

Large operating cash flows or cash from operations should NOT eliminate the need for borrowing as borrowing (long-term debt) has a lower cost of usage or is cheaper as compared to using retained earnings (part of cash generated by the firm's operations). Even though very high borrowing increase default risk of a firm, thereby pushing up its cost of using other means of financing (such as retained earnings, common stock, and preferred stock), borrowings in a suitable amount is beneficial because its and is value accretive owing to the tax-deductible nature of interest on borrowing.

As for the other statements, it is beneficial to pay off current bills (current liabilities) using operating cash flows, operating cash flows fund growth easily and a close match of net income with operating cash flow imply a sound business.

Hence, the correct is (b)