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Accruals and the prediction of future cash flows
Francois Brochet, New York University
Seunghan Nam, Rutgers University
Joshua Ronen, New York University
ABSTRACT. This paper revisits the role of the cash and accrual components of accounting earnings with respect to the prediction of future cash flows using the following key methodological features: out-of-sample predictions, firm-specific regression estimates, and different levels of aggregation of the dependent variable, with market value of equity as a proxy for all future cash flows. Using quarterly data, we find that absolute prediction errors are, on average, smaller when aggregate accruals are added as a predictor compared to current cash flow from operations alone. Accruals' contribution tends to be larger for greater levels of aggregation of the dependent variable and most significant when we predict current or one-quarter-ahead market capitalization, including in terms of second-degree stochastic dominance. Overall, our results support the argument from FASB that accrual accounting helps the prediction of future cash flows.
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