To assess the estimated persistence of cash flows and accruals by critical discussion of existing research work findings.
To determine whether earnings components like cash flow and accruals are better at predicting performance compared to other financial elements and also which of the two is comparatively better when assessed against one another.
To do a complete assessment using US sample data from Compustat for a time period of 10 years.
The research findings will be useful in the context of informing financial analysts. Financial analysis will improve heavily when there is detailed cash flow information. The significance of cash flow accounting and accrual based practices have to be understood based on persistence and prediction capabilities in order to inform analysts. A benchmark study is needed to show evidence on why policy makers have to formulate better line of reporting with respect to cash flows. Furthermore, where there are choices of earnings component to be used in prediction, the analysts must have an idea of what to choose based on the context. It is also important to understand how accruals and cash flows need to be linked in order to assess earning quality.
Cash Flow and Accrual Accounting
Accrual is an earning component that could be useful for predicting future cash flows. Accrued expenses are incurred on the balance sheet date. However, they are recorded as current liabilities because they have not been paid out. The main focus of accrual accounting is hence to record such expenses that are not yet paid. This is different from the cash accounting form as in the cash accounting form income is usually recorded as and when the payment is received. While cash and accrual are both accepted methods, accrual is the one that is mandated as required under the GAAP. It would be difficult to actually determine an exact way in which one accounting method might be better than another because the manner in which the income to company and expenses incurred are recognized could be different (Zhou, 2016; Kormendi, & Lipe, 1987)
Earning components and their effects on predicting future financial performance of firms have been researched based on their persistence. The main aim was to analyse the extent to which cash flow and accruals are significant predictors and to understand the differences when using them. To that extent, the research also covered literature backdrop on the earnings components.
The assessment for accruals and cash flow was conducted with ten-year data from 30 companies that was collected from the Computstat database. It was established that future earning assessments can indeed be predicted with the accrual and cash flow earnings of past or current years. The research finding was also supported by evidence in existing research which also emphasized on the point that better disclosures and accounting practices could improve the efficiency of prediction. The assessment was conducted as a comparative analysis, however was not able to clearly establish which of the two -accruals or cash flows would help with better prediction. This is a limitation of the research. Future extension of the research work can consider persistence concerns with cash flow and accruals to check where one might work better than another. However, this would be based on context, firm, their accountability practices, and compliance to disclosures.
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