A Mathematical Theory of Accounting and Discounted Cash Flows

This paper develops a novel theory of accounting, in the form of a quantitative language, capable of reformulating, generalizing, and studying the discounted cash flow model, in plain accounting terms - going through the reformulation of the underlying future cash flows and their financing. This language reveals new facets of value creation mechanisms, specifically certain dynamic-financial limits (e.g., internal rate of return, cash flow sustainable growth rate) whose level is intrinsically tied to the shape of the fundamental accounting entries, describing the economic activities conducted by companies. Our findings, as to value creation mechanisms, correspond to various empirical observations on stock returns and its major factors (e.g., cash flows, payment terms, growth, inflation and financing rates). This correspondence suggests an original and complementary explanation to those advanced in the literature and finally suggests levers for managers to push back limits, increase cash flows, create more value and generate stock returns