FASB was Right: Earnings Beat Cash Flows when Predicting Future Cash Flows

Abstract

Do accruals-based accounting earnings provide better information to investors about future operating cash flows than operating cash flows themselves, as predicted by FASB’s conceptual framework? The most recent evidence (Nallareddy et al., 2020) is that operating cash flows, measured correctly using cash flow statement data, consistently outperform earnings. However this evidence compares operating cash flows with “bottom line” earnings, handicapping earnings by including non-operating and transitory components with no corresponding operating cash flow. Operating earnings consistently dominate operating cash flow’s predictive ability in a battery of tests, especially after addressing cross-sectional differences among firms.

Keywords: Operating Cash Flow, forecasts, predictive ability, earnings, FASB, accruals, informativeness

JEL Classification: G11, G12, G17, M41, M48