An Analysis of the Predictive Ability of Direct Cash Flow Information Under IFRS

Abstract

In this paper, we examine the predictive ability of direct cash flow information under IFRS. Employing a combination of in- and out-of-sample cross sectional models, we provide the first empirical evidence on the predictive ability of direct cash flow information in an IFRS environment. Under IFRS, our models show the greatest explanatory power and lowest forecast errors when utilising information found only in a direct cash flow statement. Crucially, after controlling for size, we note that while our direct cash flow models report lower forecast errors for large firms, they produce no better forecasts for small firms than a parsimonious operating cash flow model. While confirming the predictive ability of direct cash flow information in an IFRS setting, our results question the benefit of the IASB and FASB mandating direct cash flow statements for small firms.

Keywords: Statement of cash flows, Direct method, Cash flow forecasts, International Financial Reporting Standards, IFRS

JEL Classification: G24, G29, M40, M41