Question

1. Explain clearly why it is possible that, for the same firm, for the same time period:

(a) Sales may rise but net income fall.

(b) Net Income may rise but cash flow fall.

(c ) Net income may rise but stock price fall.

(d) Dividends rise but stock return fall.

Answer 1

a)This may be due to many reason such as increase in variable cost of sales , additional cost or any extraordinary event that result in loss which leads to lower net income .

In short increase cost or loss may lead to lower net income inspite of increase in sales .

b)Income staement is prepared on accrual basis (that is whether cash is received or not ,paid or not) transactions are recorded whereas cash flow is prepared on cash basis .

It may be possible that most of the sales are made on credit (recorded in income statement) however increase in credit sales will increase accounts receivable .Increase in accounts receivable (current asset) will reduce net income as such increase is subtracted while calculating net cash flow from operating activity .

So there are many items that effect which result in net income but decreasing cash flow.

c)stock price are affected when the firm releases its earning report .The stock price of a firm is based on earning report of a firm .so when actual results are declared the price of a stocks are adjusted.

d)Inspite of increased dividend ,stock return fall because stock returns consists of dividend and capital gain so it may be possible the current stock price is less than the price at which stock is purchased resulting in negative return . Because of such high negative capital loss the overall return becomes negative(fALL,exceed the dividend return )