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Cash flow disaggregation and the prediction of future earnings

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  • Neal Arthur
  • Marco Cheng
  • Robert Czernkowski

Abstract

We examine the incremental information content of the components of cash flows from operations (CFO). Specifically the research question examined in this paper is whether models incorporating components of CFO to predict future earnings provide lower prediction errors than models incorporating simply net CFO. We use Australian data in this setting as all companies were required to provide information using the direct method during the sample period. We find that the cash flow components model is superior to an aggregate cash flow model in terms of explanatory power and predictive ability for future earnings; and that disclosure of non‐core (core) cash flows components is (not) useful in both respects. Our results are of relevance to investors and analysts in estimating earnings forecasts, managers of firms in regulators’ domains where choice is provided with respect to the disclosure of CFO and also to regulators’ deliberations on disclosure requirements and recommendations.

Suggested Citation

  • Neal Arthur & Marco Cheng & Robert Czernkowski, 2010. "Cash flow disaggregation and the prediction of future earnings," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 50(1), pages 1-30, March.
    • Handle: RePEc:bla:acctfi:v:50:y:2010:i:1:p:1-30
    DOI: 10.1111/j.1467-629X.2009.00316.x
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    1. Hojatollah Atashi Golestani & Seyyed Mohammad Hosseini & Ehsan Mehrjoo, 2017. "Separating and Merging Cash Flows: Investigating Five-element Cash Flows Statement," International Journal of Economics and Financial Issues, Econjournals, vol. 7(4), pages 54-61.
    2. Bond, David & Czernkowski, Robert & Lee, Yong-Suk & Loyeung, Anna, 2017. "Market reaction to non-GAAP earnings around SEC regulation," Journal of Contemporary Accounting and Economics, Elsevier, vol. 13(3), pages 193-208.
    3. Bradley Blaylock & Bradley P. Lawson & Michael A. Mayberry, 2020. "Taxable income, future profitability, and stock returns," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 47(7-8), pages 858-881, July.
    4. Farshadfar, Shadi & Monem, Reza, 2013. "Further Evidence on the Usefulness of Direct Method Cash Flow Components for Forecasting Future Cash Flows," The International Journal of Accounting, Elsevier, vol. 48(1), pages 111-133.
    5. Baljit K. Sidhu & CHUAN YU, 2021. "Direct Method Operating Cash Flow Disclosures: Determinants and Incremental Usefulness," Abacus, Accounting Foundation, University of Sydney, vol. 57(3), pages 421-467, September.
    6. Martina K. Linnenluecke & Jacqueline Birt & Xiaoyan Chen & Xin Ling & Tom Smith, 2017. "Accounting Research in Abacus, A&F, AAR, and AJM from 2008–2015: A Review and Research Agenda," Abacus, Accounting Foundation, University of Sydney, vol. 53(2), pages 159-179, June.
    7. Li Yu (Colly) He & Sue Wright & Elaine Evans, 2018. "Is fair value information relevant to investment decision-making: Evidence from the Australian agricultural sector?," Australian Journal of Management, Australian School of Business, vol. 43(4), pages 555-574, November.
    8. Iain Clacher & Alan Duboisée Ricquebourg & Allan Hodgson, 2013. "The Value Relevance of Direct Cash Flows under International Financial Reporting Standards," Abacus, Accounting Foundation, University of Sydney, vol. 49(3), pages 367-395, September.
    9. Shadi Farshadfar & Reza Monem, 2013. "The usefulness of operating cash flow and accrual components in improving the predictive ability of earnings: a re-examination and extension," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 53(4), pages 1061-1082, December.
    10. Ehsan Khansalar & Eilnaz Kashefi-Pour, 2020. "The usefulness of the double entry constraint for predicting earnings," Review of Quantitative Finance and Accounting, Springer, vol. 54(1), pages 51-67, January.
    11. Coulton, Jeffrey J. & Saune, Naibuka & Taylor, Stephen L., 2022. "Are analysts' cash flow forecasts associated with improved earnings quality? Australian evidence," Pacific-Basin Finance Journal, Elsevier, vol. 73(C).
    12. Surendranath Jory & Thanh Ngo & Hongxia Wang, 2021. "Non‐operating earnings and firm risk," Review of Financial Economics, John Wiley & Sons, vol. 39(1), pages 95-123, January.
    13. David Bond & Martin Bugeja & Robert Czernkowski, 2012. "Did Australian Firms Choose to Switch to Reporting Operating Cash Flows Using the Indirect Method?," Australian Accounting Review, CPA Australia, vol. 22(1), pages 18-24, March.
    14. Sompong Pornupatham & Hun-Tong Tan & Thanyaluk Vichitsarawong & G-Song Yoo, 2023. "The Effect of Cash Flow Presentation Method on Investors’ Forecast of Future Cash Flows," Management Science, INFORMS, vol. 69(3), pages 1877-1900, March.
    15. Michael Bradbury, 2011. "Direct or Indirect Cash Flow Statements?," Australian Accounting Review, CPA Australia, vol. 21(2), pages 124-130, June.
    16. Hunjra, Ahmed Imran & Niazi, Ghulam Shabbir Khan & Akbar, Syed Waqar & Rehman, Kashif-Ur-, 2011. "Application of finance techniques: an empirical analysis of pakistani corporate sector," MPRA Paper 40675, University Library of Munich, Germany.
    17. Richard Kent & Jacqueline Birt, 2021. "IAS 7 and value relevance: the direct method versus the indirect method," Review of Accounting Studies, Springer, vol. 26(4), pages 1532-1586, December.

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