Disaggregating Operating and Financing Activities: Implications for Forecasts of Profitability

Abstract

Researchers, practitioners, and standard setters emphasize the importance of disaggregating financial statements into operating and financial activities. However, there is a lack of research demonstrating that this disaggregation improves forecasts of profitability. In this study, we consider whether and when the operating/financial disaggregation improves forecasts of profitability. Contrary to the use of an ‘aggregate’ forecasting approach by most related prior research, we first show that the operating/financial disaggregation only provides forecast improvement over a benchmark model incorporating aggregate information when the ‘components’ forecasting approach is used. We also compare the operating/financial disaggregation to the unusual/infrequent disaggregation currently required by U.S. GAAP. We find that the operating/financial disaggregation yields less accurate forecasts than the unusual/infrequent disaggregation. However, when using the ‘components’ forecasting approach, we find that the co bination of both disaggregations improves forecasts of profitability. Finally, we document that the incremental usefulness of the operating/financial disaggregation relative to a benchmark model incorporating aggregate information is a function of growth and accounting conservatism. Overall, our study provides timely evidence concerning how analysts and investors might best use the operating/financial disaggregation for forecasting profitability.

Keywords: disaggregation, operating, financing, unusual or infrequent

JEL Classification: M41