Chartered Financial Analyst (CFA) Level 1 Practice Exam

When analyzing a company's liquidity, which cash flow measurement is typically utilized?

1. Free cash flow to equity

2. Net income

3. Free cash flow to the firm

4. Operating cash flow

The correct answer is: Operating cash flow

The measurement that is typically utilized when analyzing a company's liquidity is operating cash flow. Operating cash flow reflects the cash generated by a company's regular business operations, showing the ability of the company to generate cash flows from its core operational activities. This indicator is critical for assessing liquidity because it provides insights into whether the business can cover its short-term obligations without needing to rely on financing or other sources of cash. A company may have substantial profits on paper, indicated by net income, but if it lacks sufficient operating cash flow, it may struggle with liquidity. Other cash flow metrics, like free cash flow to equity or free cash flow to the firm, are more relevant for assessing overall financial health or valuing the company, particularly in the context of investment decisions or mergers and acquisitions. However, they do not provide the immediate visibility into a company's operational cash generation as operating cash flow does. Thus, when evaluating liquidity specifically, operating cash flow is the most pertinent metric.