Article2011

Accruals and the prediction of future cash flows

53 citations0/0 files storedManagement Research Review

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Financial Reporting and Valuation Research Auditing, Earnings Management, Governance Financial Analysis and Corporate Governance

Abstract

Purpose The purpose of this paper is to examine the comparative abilities of current period cash flows and earnings (and its components) to predict one‐year‐ahead cash flow from operations in Egypt. Design/methodology/approach The study uses the cash flow prediction models developed by Barth, Cram, and Nelson to examine the predictive abilities of earnings and cash flows for future cash flows. The first set of prediction models uses cross‐sectional regression to compare the predictive abilities of cash flows and aggregate earnings for one‐year‐ahead cash flow from operations. The second set of prediction models tests whether disaggregating earnings into cash flows and the major components of accruals enhances the predictive ability of earnings for one‐year‐ahead cash flow from operations. Findings The findings of the study reveal that aggregate earnings have superior predictive ability than cash flows for future cash flows. Also, the results reveal that disaggregating accruals into major components – changes in accounts receivable and payable, and in inventory, depreciation, amortization, and other accruals – significantly enhances predictive ability of earnings. Research limitations/implications The study provides empirical evidence on the superiority of earnings in predicting future cash flows. The findings of the study should be considered in explaining the results of value relevance research Egypt. However, owing to relatively small sample size, given the thinness of the Egyptian capital market, these findings should be interpreted with caution. Originality/value The paper contributes to the limited body of research on the superiority of earnings and cash flows in predicting future cash flows by examining the predictive abilities of earnings and cash flows for future cash flows in Egypt as one of many emerging markets.

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References

2003Earnings management and investor protection: an international comparison 2000The effect of international institutional factors on properties of accounting earnings 2008Mandatory IFRS Reporting around the World: Early Evidence on the Economic Consequences 2003Incentives versus standards: properties of accounting income in four East Asian countries 1999The Boundaries of Financial Reporting and How to Extend Them 1999Have Financial Statements Lost Their Relevance?1997Changes in the value-relevance of earnings and book values over the past forty years 2006The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms

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