Implications of Cost Behavior for Analysts' Earnings Forecasts

ABSTRACT Recent work in management accounting offers several novel insights into firms' cost behavior. This study explores whether financial analysts appropriately incorporate information on two types of cost behavior in predicting earnings—cost variability and cost stickiness. Since analysts' utilization of information is not directly observable, we model the process of earnings prediction to generate empirically testable hypotheses. The results indicate that analysts “converge to the average” in recognizing both cost variability and cost stickiness, resulting in substantial and systematic earnings forecast errors. Particularly, we find a clear pattern—inappropriate incorporation of available information on cost behavior in earnings forecasts leads to larger errors in unfavorable scenarios than in favorable ones. Overall, enhancing analysts' awareness of the expense side is likely to improve their earnings forecasts, mainly when sales turn to the worse. JEL Classifications: M41; M46; G12.

THE RELATIONSHIPS OF CASH FLOWS: EVIDENCE FROM LATVIAN COMPANIES

The paper deals with the subject of relationships among the different cash flows, as well as earnings, of a company. The aim of the paper is to establish the direction and strength of mutual relationships between different cash flow measures, as well as with earnings, and to provide recommendations for the prediction of future cash flows and earnings. The methods of the research include content analysis, the calculation of relative indicators, average and median measures, as well as regression and correlation analysis. There is an empirical study of the data of 52 Latvian companies, which has resulted in testing the hypotheses put forward and substantiated in the paper. A typical Latvian enterprise relies on the operating cash flow to create the investing cash flow and does not need to rely on the external sources of financing. The author concludes that investment does pay, and, based on the assessment of results of the developed model, the investing cash flow should be used in cash flow prediction, while it should not be used in earnings prediction. The increase in financing cash flow causes a company investments to increase.