Was wondering about the rationale for using “Operating Cash Flow / Operating Income” to measure earnings quality (ie to see whether earnings are backed by cash).
I think Operating income (EBIT) is not really comparable with operating cash flows due to the depreciation & amortization component in EBIT. Therefore do you think Operating cash flows / EBITDA would be a better metric?
Thanks in advance
No. Depreciation and amortization impact is already considered in CFO in numerator.
yes D&A is considered by adding it back in the calculation of OCF (basically removing any effect of D&A in cash flows). But in EBIT D&A is subtracted.
so basically when you calculate OCF from net income, you start by adding tax expenses, interest expense, and other non cash expenses/gains (including D&A) which I think takes you closer to EBITDA but not EBIT.
Thanks.