Earnings versus cash flows as predictors of future cash flows: New Zealand evidence

Abstract

This study examines the predictive ability of earnings and reported cash flow measures (i.e., Cash Flow From Operations [CFFO], Cash Flow From Investing Activities [CFFIA], and Cash Flow From Financing Activities [CFFFA]) to forecast one- and two-period ahead cash flows during the period 1989-92, using predictive models based on research methodology applied by Bowen, Burgstahler and Daley [1986]. The degree of relationship between earnings and cash flow measures is also examined as a secondary goal of the study. The results provide evidence that CFFO (CFFIA) is a better predictor of one- and two-period ahead CFFO (CFFIA) than is earnings and CFFFA is a better predictor of two-period ahead CFFFA than is earnings. The results of the correlations show that the traditional cash flow measures (i.e., net income plus depreciation and amortisation [NIDPR], and working capital from operations [WCFO]) are highly correlated with earnings suggesting that they both are similar, while the correlations between reported cash flow measures and traditional cash flow measures are low suggesting that the traditional cash flow measures used in prior research are poor proxies for reported cash flow measures which are now provided by the companies' statement of cash flows as required by the New Zealand's Financial Reporting Standard No.10.