Predicting Accruals Based on Cash-Flow Properties

Posted: 5 Jan 2018

See all articles by Richard M. Frankel

Richard M. Frankel

Washington University in Saint Louis - Olin Business School

Yan Sun

Saint Louis University

Date Written: January 2, 2018

Abstract

Our goal is to understand the extent to which cash-flow properties explain accruals. Using the Dechow et al. (1998) model, we derive a negative relation between accruals and cash-flow changes and show that the strength of the relation is linked to negative serial correlation in cash-flow changes. Dechow et al. also suggest that the strength of the relation between accruals and revenue changes relates to operating-cycle length. Prior accrual models have not incorporated these theoretical relations. We show that incorporating cash-flow changes, serial correlation in cash-flow changes, and operating-cycle length increases explanatory power of all accrual models considered (i.e., Jones; Ball and Shivakumar; McNichols; and Jeter and Shivakumar). We find that incorporating these variables in accrual models also improves specification and power, aids detection of earnings management in AAER firms, and produces a nondiscretionary-accrual estimate that better predicts future cash flows and earnings. These results suggest the importance of considering the economic role of accruals when predicting accruals.

Keywords: accruals; cash-flow properties; serial correlation in cash-flow changes

JEL Classification: M40

Suggested Citation

Frankel, Richard M. and Sun, Yan, Predicting Accruals Based on Cash-Flow Properties (January 2, 2018). Available at SSRN: https://ssrn.com/abstract=3095776

Richard M. Frankel (Contact Author)

Washington University in Saint Louis - Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Yan Sun

Saint Louis University ( email )

3674 Lindell Blvd
St. Louis, MO 63108-3397
United States

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