Net Income Plus Depreciation, Operating Cash Flow and Buildups in Operating Working Capital
Mulford, Charles W.
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While there are many advantages to a simple and readily available proxy for operating cash flow, there are inherent shortcomings as well. Such is the case with net income plus depreciation & amortization, a metric sometimes referred to as "cash earnings." In particular, net income plus depreciation & amortization does not take changes in operating working capital into account. This report identifies several companies where in recent years, net income plus depreciation & amortization has been growing but where reported operating cash flow has been lagging. At these companies, operating working capital, including accounts receivable and especially, inventory, is not being realized and is increasing, in some cases, rapidly. The rapid growth in such accounts calls into question the sustainability of future earnings as the risk of write down and accompanying loss increases. While a write-down can be averted if accumulating operating working capital is ultimately realized, such was not the case at KB Home, or DR Horton, Inc., where write-downs of the companies' inventory of landholdings were recently announced.