Discuss how Ingram and Lee used the cash flow statement in conjunction with the income statement for analytical purposes.

Question

What will be an ideal response?

Answer 1

ANSWER:
Ingram and Lee used the income statement and the cash flow statement together and posited that, over time, growing firms will have higher income and lower cash flows. This is because growing firms will have increasing inventories and accounts re-ceivable as they expand. To some extent, the inven-tories and receivables will be offset by increases in payables, but the net effect of the growth in work-ing capital is that a change in income each year will exceed the change in operating cash flow. In addi-tion, as a firm expands, there will be net investment outflows as fixed assets are acquired and cash in-flows from financing as new debt and equity are floated and dividends are likely cut back. For a firm that is contracting, the relationships will large-ly run in reverse. Ingram and Lee’s statistical anal-ysis largely supported their deductive analysis.