Q1: Can a company reply on net income as a valid measure of cash needed to...

Q1: Can a company reply on net income as a valid measure of cash needed to pay fixed charges? Explain you answer

Q2: Explain why companies do not include principle payment requirement when calculating earnings to fixed charges ratio.

Expert Solution

Question-1

Net Income can't be a reliable measure of fixed charges payment.The net income is the sum total of notional as well as cash income.In some instances the notional inflows may outperform real cash inflows,in that cases if we look the net income index there will be false view that the net income can cover the fixed charges.For example,A Ltd. have a total income of 10 million,out of which 5 million in real cash inflows from sales,1 million is real cah income from investments and 4 million is the profit on revauation.A Ltd. have a fixed charge of 7 milllion.If the net income is considered as a measure,total income will be 10 million and the evaluation that the fixed charges is payable will be a misleading one as the company can only bear a 6 million at it's maximum.So it is concluded that net income method is misleading to measure the fixed expense payment ability.Rather more accurate evalution methods like real cash inflows may be considered.While considering real cash inflow as an index for future payment,consider necessary variances prevailing in business environment.

ekkarill92 answered 1 year ago

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