The Changing Landscape of Accrual Accounting: Implications for Operating Cash Flow Predictability

• In Event: The Relation Between Earnings, Cash Flows, and Accruals

Abstract

Recent evidence suggests that contemporaneous accruals-cash flows correlations have changed dramatically over the last four decades. We investigate the implications of this changing landscape for cash flows predictability. We have two key insights. First, we find that earnings’ ability to predict future cash flows is increasing over the period 1989-2015. However, this trend is attributable to the increasing predictive ability of cash flows rather than accruals. That is, while cash flows show an increasing ability to predict future cash flows over time, accruals show no such trend. The increasing predictive ability of cash flows is associated with shortening operating cycles, decreasing working capital accruals, and increasing intensity of intangibles over time. Second, contrary to conventional wisdom and findings from recent literature, we document that cash flows are superior to earnings in predicting future cash flows. We attribute the different findings in prior research to measurement errors induced by the balance sheet method of estimating accruals and cash flows. The evidence in the study has implications for accounting educators, academics, practitioners, and standard setters.

Authors

• Suresh Nallareddy, Duke University

• Mani Sethuraman, Cornell University

• Mohan Venkatachalam, Duke University