The Review of Literature on the Role of Earnings, Cash Flows and Accruals in Predicting of Future Cash Flow

Abstract

The purpose of this paper is to review academic literature on prediction of firm's future cash flow, which is the fundamental issue in accounting and finance investigated under capital market-based accounting research. We begin by presenting the main findings regarding the important role played by earnings, cash flow from operations and accruals in predicting future cash flows followed by the methodology used. The findings from this literature show that the results are inconsistent with FASB assertion. Instead, most of the studies report that cash flow from operations is a better predictor of future cash flows, whereas some researchers support the assertion. However, other researchers have shown that the ability of earnings improved when it is disaggregated into its major accruals components. This inconsistency in the results was due to the following reasons; methodological differences; measurement error in the predictor variables and the period covered by the study. Overall the paper provides additional insight to readers who wish to familiarize with this line of research and provides possible areas for further research.

Accruals in the Prediction of Forthcoming Cash Flows in the Companies Listed at Pakistan Stock Exchange

“…On the other hand, investors who are making investment decisions in stocks using such predicted future cash flows could not see actual stock price as it deviates from its fundamental values (Dechow et al, 2019;Lewellen and Resutek, 2016). As the accruals represented in financial statements manipulated through earnings management (Mulenga and Bhatia, 2017), this study shows how disaggregated accruals like trading accruals, non-trading accruals and financial accruals with their relevant component -assets and liability affect the forecast of forthcoming cash flows in companies listed at Pakistan Stock Exchange.…”

الأرباح مقابل التدفقات النقدیة فی التنبؤ بالتدفقات النقدیة المستقبلیة دلیل من الشرکات المصریة والسعودیة(باللغة الإنجلیزیة)

“…The concept of cash flow prediction is extremely important for both professionals and academics, as it helps users of financial statements to assess the liquidity, flexibility and financial risks of a company (Barth et al, 2001;Mulenga and Bhatia, 2017). Many researchers have been interested in cash flow information, as much of their attention has focused on the FASB assertion that implies accounting earnings based on accrual accounting are better in predicting operating cash flows than the operating cash flows themselves.…”

The ability of cash flows to predict the earning

“…Cash flow in accounting, the balance sheet is a snapshot on a company's finances at a fixed time; that reflect the changes in company finance over a long period. Cash flow prediction to be the most important and useful factor required in the various economic decision like investment decision, lending decision and other financial decision by accounting information users (Mulenga, Bhatia ,2017) (Chotkunakitti, 2005), because it helps them in assessing firm's liquidity, financial flexibility and risks (Barth et al,.2001).Furthermore, FASB (1978 observed the task of predicting future cash flow as the primary objective of financial reporting (Mulenga, Bhatia, 2017).…”

“…The concept of cash flow prediction is not only interesting and important for the company's business, investors, creditors, financial analysts among others but also for academic researchers (Mulenga, Bhatia, 2017). Through prediction of cash flow financial statements users are able to assess firm's liquidity, financial flexibility and risks (Barth, Beaver, & Landsman, 2001;Bhatia & Dhamija, 2015;Mulenga, Bhatia, 2017) The importance of Future Cash Flow Prediction. The availability of an optimum level of Cash to a firm is "king".…”