The Relative Ability of Earnings and Cash Flow Data in Forecasting Future Cash Flows : Some Australian Evidence

Purpose: This paper examines the relative predictive ability of earnings, cash flow from operations as reported in the cash flow statement, and two traditional measures of cash flows (i.e. earnings plus depreciation and amortisation expense, and working capital from operations) in forecasting future cash flows for Australian companies. Further, an empirical investigation of the extent to which firm size, as a contextual factor, influences the predictability of earnings and cash flow from operations is presented.Methodology: Our sample includes 323 companies listed on the Australian Stock Exchange between 1992 and 2004 (3,512 firm-years). We employ the ordinary least squares and fixed-effects approaches to estimate our regression models. To evaluate the forecasting performance of the regression models, both within-sample and out-of-sample forecasting tests are employed.Findings: We provide evidence that reported cash flow from operations has more power in predicting future cash flows than earnings and traditional cash flow measures. Further, the predictability of both earnings and cash flow from operations significantly increases with firm size. However, the superiority of cash flow from operations to earnings in predicting future cash flows is robust across small, medium and large firms