The usefulness of accounting measures in predicting future cash flow

Master's Thesis , 2021 , 56 Pages , Grade: 1,0

Business economics - Accounting and Taxes

The primary aim of this study is to empirically examine the relative ability of accounting earnings and cash flow to predict future cash flow. Moreover, the role of accruals in cash flow predictions is called into question. One of the major purposes of financial reporting consists in ensuring an informational basis that helps investors, creditors and other users of accounting data to overcome the uncertainty associated with the future cash flows of enterprises their financial activity relates to. At the same time, the accrual concept prevails in modern accounting, since it is theorized to mitigate the mismatching and timing problems of the unrefined cash ba-sis accounting.

Hence, recognizing revenues and expenses in the period when they have occurred, and not when cash was received or paid out, should create a more relevant framework for decision making. The use of accrual accounting earnings as a summary measure of financial performance instead of the more primitive cash flows is therefore advocated by accounting standard setters. For instance, the Financial Accounting Stand-ard Board claims that: “Information about enterprise earnings and its components measured by accrual accounting generally provides a better indica-tion of enterprise performance than information about current cash receipts and pay-ments”.

The FASB’s statement led to a rising discussion in the financial research on whether accounting earnings provide a more reliable picture of a company’s future operating cash flows than current operating cash flows themselves do. Hence, a major implication of the above quotation refers to the incremental power of accruals and its components in predicting future cash flows beyond the one contained into current operating cash flows. This debate represents a cornerstone in evaluating the information quality offered by the accrual accounting concept.

Inhaltsverzeichnis (Table of Contents)

• 1. Introduction
• 2. Literature Overview
• 3. Research design
  • 3.1 Models and methodology
  • 3.2 Data and sample
  • 3.3 Descriptive statistics
• 4. Results
  • 4.1 In-sample regressions
    • 4.1.1 Aggregate earnings and cash flow
    • 4.1.2 Disaggregated earnings
    • 4.1.3 Cash flow decomposition
  • 4.2 Rolling window regressions
    • 4.2.1 Parameter estimates
    • 4.2.2 Summary statistics of the model-based and analysts' forecasts
    • 4.2.3 Error measures and performance of the model-based forecasts
    • 4.2.4 Relative performance of the model-based and analysts' forecasts
• 5. Additional tests
  • 5.1 Undeflated data
  • 5.2 Alternative earnings variable
• 6. Conclusion

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This study aims to empirically examine the relative ability of accounting earnings and cash flow to predict future cash flow. The study also investigates the role of accruals in cash flow predictions, challenging the assertion of the Financial Accounting Standards Board (FASB) that accrual earnings provide a better indication of enterprise performance than current cash receipts and payments. Key themes explored in the study include:

• The predictive power of accounting earnings and cash flow in relation to future cash flow
• The role of accruals in forecasting future cash flows
• The impact of different accounting models on cash flow predictions
• The performance of model-based forecasts compared to analysts' forecasts
• The implications of the study's findings for decision-making in finance and accounting

Zusammenfassung der Kapitel (Chapter Summaries)

• Chapter 1: Introduction: This chapter introduces the research topic and provides a brief overview of the debate on the relative predictive power of accounting earnings and cash flow. It highlights the importance of cash flow predictions for financial decision-making and outlines the objectives and structure of the study.
• Chapter 2: Literature Overview: This chapter summarizes the existing literature on forecasting future cash flows using accounting variables. It discusses the classical approach of comparing the predictive power of earnings and cash flow, reviewing earlier studies and their findings.
• Chapter 3: Research design: This chapter outlines the methodology and research design used in the study. It details the models used, the data sources, the sample selection criteria, and the statistical methods applied.
• Chapter 4: Results: This chapter presents the results of the empirical analysis. It examines the predictive power of accounting earnings and cash flow using both in-sample regressions and rolling window regressions, and compares the performance of model-based forecasts to analysts' forecasts.
• Chapter 5: Additional tests: This chapter explores alternative specifications and sensitivity analyses, such as the use of undeflated data and an alternative earnings variable.

Schlüsselwörter (Keywords)

This study focuses on the crucial role of accounting measures, particularly earnings and cash flow, in predicting future cash flows. It delves into the debate surrounding the relative predictive power of these measures, examining the impact of accrual accounting and the performance of model-based forecasts. Key terms include: cash flow forecasting, accounting earnings, cash flow from operations, accruals, model-based forecasts, analysts' forecasts, predictive power, and financial reporting.

• College: University of Cologne
• Grade: 1,0
• Author: Nikolay Draganov (Author)
• Publication Year: 2021
• Pages: 56
• Catalog Number: V1042170
• ISBN (eBook): 9783346463401
• ISBN (Book): 9783346463418
• Language: English
• Tags: Corporate Finance, Valuation, Accounting, Cash flow, prediction, forecasting, dechow, kothari, watts, barth, brealey, myers, finger, chen, nelson, cram, ball, nikolaev, nikolay, draganov, financial, reporting, model, hou, van dijk, zhang, hribar, collins, kim, kross, fasb, standards, unternehmensbewertung, transaction, due diligence, sfac, usefulness, cfo, cash flow from operations, cashflow aus operativer tätigkei, cash flow from financing, cash flow from investment activity, kapitalflussrechnung