An Analysis Of The Comparative Predictive Abilities Of Operating Cash Flows, Earnings, And Sales

Prior studies (e.g., Greenburg et al., 1986; Murdoch and Krause, 1989) provide evidence that earnings outperforms historical cash flows in predicting future cash flows. Later research (e.g., Barth et al., 2001) demonstrates that the major accrual components of earnings each possess significant explanatory power in predicting future cash flows and that they augment, rather than replace, the predictive ability of aggregate earnings.  The current study furthers this work by examining the predictive power of another major component of earnings, i.e., sales.  Using share price as the dependent variable and as a proxy for future cash flows, this study compares the predictive abilities of changes in operating cash flows, earnings, and sales.  Similar to the findings in prior research, earnings predicts better than operating cash flows.  More importantly, however, sales predicts with greater accuracy than either operating cash flows or earnings.

Download Full-text

The relative predictive ability of earnings and cash flows

Management Research Review ◽

10.1108/mrr-06-2013-0156 ◽

2015 ◽

Vol 38 (4) ◽

pp. 367-380

Author(s):

Varun Dawar

Keyword(s):

Prediction Models ◽

Explanatory Power ◽

Predictive Ability ◽

Cash Flows ◽

Financial Accounting ◽

Accounting Standard ◽

Content Type ◽

Aggregate Earnings ◽

Future Cash Flows

Purpose – The purpose of this paper is to examine the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows in case of Shariah-compliant companies in India. Design/methodology/approach – The study uses the list of CRISIL NSE Index (CNX) Nifty Shariah Index companies as its sample for a period of 10 years for conducting the analysis. The study utilizes the cash flow prediction models to examine the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows. Findings – The study report that contrary to Financial Accounting Standard Board assertion, current cash flows have superior predictive ability of next period cash flows than current aggregate earnings in case of Shariah-compliant companies in India. The results further show that there are no gains from decomposing earnings into accruals and cash flows in predicting future cash flows. There is no increase in explanatory power (measured by adjusted R2) when aggregate earnings are disaggregated into accruals and cash flows to predict next period cash flows. Practical implications – The empirical findings of the study will enable the Shariah compliant investors to understand the role of current earnings (and its components) and cash flows in predicting next period cash flows in case of Shariah-compliant companies in India. Originality/value – To the best of author’s knowledge, this is the first study which examines the relative predictive abilities of current earnings (and its components) and cash flows for next period cash flows in case of Shariah-compliant companies in India.

Download Full-text

Accruals and the Prediction of Future Cash Flows

The Accounting Review ◽

10.2308/accr.2001.76.1.27 ◽

2001 ◽

Vol 76 (1) ◽

pp. 27-58 ◽

Cited By ~ 467

Author(s):

Mary E. Barth ◽

Donald P. Cram ◽

Karen K. Nelson

Keyword(s):

Cash Flow ◽

Predictive Ability ◽

Cash Flows ◽

Accounts Receivable ◽

Accounts Payable ◽

Aggregate Earnings ◽

Industry Membership ◽

Future Cash Flows

Building on the Dechow et al. (1998) model of the accrual process, this study investigates the role of accruals in predicting future cash flows. The model shows that each accrual component reflects different information relating to future cash flows; aggregate earnings masks this information. As predicted, disaggregating accruals into major components—change in accounts receivable, change in accounts payable, change in inventory, depreciation, amortization, and other accruals—significantly enhances predictive ability. Each accrual component, including depreciation and amortization, is significant with the predicted sign in predicting future cash flows, incremental to current cash flow. The cash flow and accrual components of current earnings have substantially more predictive ability for future cash flows than several lags of aggregate earnings. The inferences are robust to alternative specifications, including controlling for operating cash cycle and industry membership.

Download Full-text

Comparing US-GAAP and Iran-GAAP operating cash flows to predict future cash flows

Journal of Financial Reporting and Accounting ◽

10.1108/jfra-06-2013-0047 ◽

2015 ◽

Vol 13 (1) ◽

pp. 39-65

Author(s):

Reza Janjani

Keyword(s):

Financial Reporting ◽

Predictive Ability ◽

Cash Flows ◽

Financial Analyst ◽

Cross Sectional ◽

Content Type ◽

Generally Accepted Accounting Principles ◽

Operating Cash Flows ◽

Statement Of Cash Flows ◽

Future Cash Flows

Purpose – The main objective of this paper is to compare the ability of US-generally accepted accounting principles (GAAP) operating cash flows versus Iran-GAAP operating cash flows in predicting future cash flows. Design/methodology/approach – The sample comprises 240 firms (1,200 firm-years) during the period from 2004 to 2008 for which operating cash flows and other variables are available. Cross-sectional and panel data regression models are used in testing the hypotheses. Findings – This study finds that operating cash flows based on Iran-GAAP are no more effective in predicting future cash flows than those based on USA-GAAP, and the predictive ability of the model is improved by adding the earnings accrual components to the operating cash flows. Originality/value – The study suggests that the Iranian accounting standard setting committee recommends that the statement of cash flows be prepared based on the three-category model instead of the five-category model in an attempt to converge with the International Financial Reporting Standards. Consistent with Financial Accounting Standards Board and financial analyst recommendations, the results reveal that earnings are a better predictor than cash flows from operations.

Download Full-text

The Comparative Predictive Abilities Of Accrual Earnings And Cash Flows In Periods Of Economic Turbulence: The Case Of The IT Bubble

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v26i1.279 ◽

2010 ◽

Vol 26 (1) ◽

Cited By ~ 6

Author(s):

Marilyn A. Waldron ◽

Charles E. Jordan

Keyword(s):

Financial Reporting ◽

Predictive Ability ◽

Cash Flows ◽

Primary Objective ◽

Decision Makers ◽

Net Income ◽

Font Size ◽

Time Period ◽

Economic Boom ◽

Future Cash Flows

As set forth in SFAC No. 1, a primary objective of financial reporting is to provide information useful to decision makers. Predicting future cash flows represents a major goal of investors and creditors, and accrual and cash flow accounting information present two alternative factors useful in such predictions. The current research investigates the comparative abilities of accrual basis net income and historical cash flows from operations as predictors of future cash flows during both the economic boom leading up to the IT Bubble and the period of economic duress following the burst of that Bubble. Generally, results indicate that historical cash flows outperform accrual net income in predicting future cash flows during these periods of economic turbulence.  Additionally, the evidence reveals great variability in the predictive ability of accrual earnings during the time period studied, suggesting that accrual accounting estimates lose some of their precision during periods of extreme economic fluctuation.

Download Full-text

Discretionary accruals and the predictive ability of earnings in the forecast of future cash flows: Evidence from Australia

Corporate Ownership and Control ◽

10.22495/cocv9i1c6art3 ◽

2011 ◽

Vol 9 (1) ◽

pp. 597-608 ◽

Cited By ~ 4

Author(s):

Shadi Farshadfar ◽

Reza Monem

Keyword(s):

Cash Flow ◽

Direct Method ◽

Predictive Ability ◽

Discretionary Accruals ◽

Cash Flows ◽

Australian Context ◽

Out Of Sample ◽

Aggregate Earnings ◽

Flow Components ◽

Future Cash Flows

We examine whether discretionary and non-discretionary accruals improve the predictive ability of earnings for forecasting future cash flows in an Australian context. Using both within-sample and out-of-sample forecasting tests; we demonstrate that discretionary accruals improve the predictive ability of earnings in the forecast of future cash flows. Further, discretionary and non-discretionary accruals and direct method cash flow components together are more useful than (i) aggregate earnings, (ii) aggregate cash flow from operations and total accruals, and (iii) aggregate cash flow from operations, discretionary accruals and nondiscretionary accruals.

Download Full-text

Discretionary Risk Disclosures

The Accounting Review ◽

10.2308/accr.2003.78.2.449 ◽

2003 ◽

Vol 78 (2) ◽

pp. 449-469 ◽

Cited By ~ 117

Author(s):

Bjorn N. Jorgensen ◽

Michael T. Kirschenheiter

Keyword(s):

Stock Returns ◽

Risk Premium ◽

Voluntary Disclosure ◽

Cash Flows ◽

Share Price ◽

Risk Disclosure ◽

Share Prices ◽

Ex Post ◽

Partial Disclosure ◽

Future Cash Flows

We model managers' equilibrium strategies for voluntarily disclosing information about their firm's risk. We consider a multifirm setting in which the variance of each firm's future cash flow is uncertain. A manager can disclose, at a cost, this variance before offering the firm for sale in a competitive stock market with risk-averse investors. In our partial disclosure equilibrium, managers voluntarily disclose if their firm has a low variance of future cash flows, but withhold the information if their firm has highly variable future cash flows. We establish how the manager's discretionary risk disclosure affects the firm's share price, expected stock returns, and beta, within the framework of the Capital Asset Pricing Model. We show that whereas one manager's discretionary disclosure of his firm's risk does not affect other firms' share prices, it does affect the other firms' betas. Also, we demonstrate that a disclosing firm has lower risk premium and beta ex post than a nondisclosing firm. Finally, we show that ex ante, the expected risk premium and expected beta of each firm are higher under a mandatory risk disclosure regime than in the partial disclosure equilibrium that arises under a voluntary disclosure regime.

Download Full-text

Do Big 4 auditors improve the ability of goodwill to forecast future cash flows?

Corporate Ownership and Control ◽

10.22495/cocv13i3c1p2 ◽

2016 ◽

Vol 13 (3) ◽

pp. 164-172 ◽

Cited By ~ 1

Author(s):

Ahmad Al-Hiyari ◽

Rohaida Abdul Latif ◽

Noor Afza Amran

Keyword(s):

Financial Reporting ◽

Predictive Ability ◽

Cash Flows ◽

Reporting Standard ◽

Accounting Firms ◽

Big 4 ◽

Business Combination ◽

Accounting Rules ◽

Future Cash Flows ◽

Professional Judgement

The accounting rules prescribed in Malaysian Financial Reporting Standard (MFRS) 3, Business combination, and (MFRS) 136, Impairment of Assets, give managers considerable reporting discretion in allocating goodwill and estimating its actual value. Agency theory predicts that managers may use the accounting discretion granted by the new rules to pursue their own interests at the expense of shareholders. Hence, auditors are required to exercise professional judgement when investigating hard-to-verify management assumptions and valuations. We exploit this issue by examining whether predictive ability of goodwill improved in the presence of Big 4 auditors. We provide evidence that goodwill has a significant predictive ability for second and third-year ahead cash flows which exists only in the firms audited by the large international reputable accounting firms. This suggests that Big 4 auditors play an important role in ensuring appropriate implementation of the present accounting for goodwill.

Download Full-text

Foreign Monitoring and Predictability of Future Cash Flow

Sustainability ◽

10.3390/su11184832 ◽

2019 ◽

Vol 11 (18) ◽

pp. 4832

Author(s):

Jaehong Lee ◽

Eunsoo Kim

Keyword(s):

Cash Flow ◽

Stock Exchange ◽

Predictive Ability ◽

Financial Statements ◽

Cash Flows ◽

Foreign Investors ◽

Future Cash Flow ◽

Flow Components ◽

Future Cash Flows

A company’s sustainability is generally determined by whether it is able to create a positive long-term cash flow. This paper investigates whether the predictive ability of cash flows and earnings in forecasting future cash flows differs depending on the foreign investors’ ownership. Based on firms listed in the Korea Stock Exchange market from 2000 to 2017, we find that earnings and cash flow components of financial statements enhance the predictability of future cash flow in the Korean stock market. Conversely, foreign investors showed a tendency to decide on investments based on operating cash flow instead of earnings when predicting future cash flow. These findings indicate that reliability towards earnings may fall since foreign investors’ concerns are on the prospects of earnings management. These results were strengthened by the addition of several more analyses including cluster analyses, consideration of information asymmetry and the chaebol governance.

Download Full-text

Earnings, Cash Flows, and Ex Post Intrinsic Value of Equity

The Accounting Review ◽

10.2308/accr.2007.82.2.457 ◽

2007 ◽

Vol 82 (2) ◽

pp. 457-481 ◽

Cited By ~ 55

Author(s):

K. R. Subramanyam ◽

Mohan Venkatachalam

Keyword(s):

Stock Returns ◽

Intrinsic Value ◽

Market Price ◽

Cash Flows ◽

Cost Of Equity ◽

Operating Cash Flows ◽

Ex Post ◽

Reported Earnings ◽

Future Cash Flows ◽

Value Measure

We reexamine the relative importance of earnings and operating cash flows in equity valuation. In contrast to previous studies that use stock returns (Dechow 1994) or future operating cash flows (Barth et al. 2001), we use ex post intrinsic value of equity as the criterion for comparison. We determine ex post intrinsic value of equity by discounting future dividends over a three-year horizon and market price at the end of the horizon by industry cost of equity. The advantage of the ex post intrinsic value measure over stock returns is that it is not contaminated by the stock market's fixation on reported earnings (Sloan 1996). Also, unlike finite horizon future operating cash flows, ex post intrinsic values better reflect the magnitude, timing, and uncertainty of investors' future cash flows (SFAC No. 1, FASB 1978). Our results suggest that accrualbased earnings dominate operating cash flows as a summary indicator of ex post intrinsic value.

Download Full-text

Predicting Material Weaknesses In Internal Control Systems After The Sarbanes-Oxley Act Using Multiple Criteria Linear Programming And Other Data Mining Approaches

Journal of Applied Business Research (JABR) ◽

10.19030/jabr.v25i6.999 ◽

2011 ◽

Vol 25 (6) ◽

Author(s):

Wikil Kwak ◽

Susan Eldridge ◽

Yong Shi ◽

Gang Kou

Keyword(s):

Data Mining ◽

Linear Programming ◽

Internal Control ◽

Foreign Currency ◽

Predictive Ability ◽

Cash Flows ◽

Multiple Criteria ◽

Font Size ◽

Sarbanes Oxley ◽

Material Weaknesses

<h1 style="TEXT-JUSTIFY: inter-ideograph; TEXT-ALIGN: justify; MARGIN: 0in 0.5in 0pt">Our study proposes a multiple criteria linear programming (MCLP) and other data mining methods to predict material weaknesses in a firm’s internal control system after the Sarbanes-Oxley Act (SOX) using 2003-2004 U.S. data.  The results of the MCLP and other data mining approaches in our prediction study show that the MCLP method performs better overall than the other data mining approaches using financial and other data from the Form 10-K report.  Consistent with prior research, firms that disclosed material weaknesses in their SOX Section 302 disclosures were more complex (based on the existence of foreign currency translations), more often used Big 4 auditors, and had lower operating cash flows-to-total assets ratios than the non-material weakness control firms.  Because of mixed results on several profitability measures and marginal predictive ability for the MCLP and other methods used, more research is needed to identify firm characteristics that help investors, auditors, and others predict material weaknesses.</h1>

Download Full-text