An Analysis Of The Comparative Predictive Abilities Of Operating Cash Flows, Earnings, And Sales

Abstract

Prior studies (e.g., Greenburg et al., 1986; Murdoch and Krause, 1989) provide evidence that earnings outperforms historical cash flows in predicting future cash flows. Later research (e.g., Barth et al., 2001) demonstrates that the major accrual components of earnings each possess significant explanatory power in predicting future cash flows and that they augment, rather than replace, the predictive ability of aggregate earnings. The current study furthers this work by examining the predictive power of another major component of earnings, i.e., sales. Using share price as the dependent variable and as a proxy for future cash flows, this study compares the predictive abilities of changes in operating cash flows, earnings, and sales. Similar to the findings in prior research, earnings predicts better than operating cash flows. More importantly, however, sales predicts with greater accuracy than either operating cash flows or earnings.