Although much of the work of an equity analyst involves quantitative analysis, some analysts also engage in various qualitative analyses to help them assess the persistence of a firm’s current earnings. Consider, for example, the case of Blockbuster Entertainment Corporation. Prior to the dominance of Netflix, Blockbuster was the leading movie rental company in the U.S. In 1989, Lee J. Seidler, a senior analyst with Bear, Stearns & Co., issued a research report critical of Blockbuster’s earnings. Mr. Seidler observed that although Blockbuster’s 1988 net income was \($15.5\) million and its cash flow from operating activities \($48.4\) million, his review of the firm’s cash flow data revealed that Blockbuster’s purchases of new videocassette rental inventory had been classified as an

“investing activity” rather than as an “operating activity” on the company’s statement of cash flow. Presented below is selected financial statement information for Blockbuster:

Discuss how the statement of cash flow can be used to help evaluate the quality of a company’s reported earnings.
Describe how Blockbuster’s cash flow data can be used to illustrate this. Do you agree with Blockbuster’s decision to classify its videocassette inventory purchases as an “investing activity”? Why or why not? How does Blockbuster’s cash flow classification of its video inventory purchases affect its cash flow from operations?

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(in millions) 1988 1987 Net income... $15.5 $4.09 Cash flow from operations... 48.3 10.3 Purchases of videocassette rental inventory 51.3) (14.3)