The Persistence of Cash Flow Components into Future Cash Flows

Abstract

We examine the persistence of cash flow components in predicting future cash flows. In this study, we evaluate six cash flow components (which parallels the direct method of the cash flow statement): cash flows related to sales, cost of goods sold, operating expenses, interest, taxes, and other. Consistent with our predictions, we find that the cash flow components from various operating activities persist differentially. We find that cash related to sales, cost of goods sold, operating expenses and interest persists a great deal into future cash flows; cash related to other has lower persistence; and cash related to taxes has no persistence. We then incorporate accrual components into our persistence regression model and find that the persistence of cash flow components are generally higher than those of accruals; however, accrual components do enhance model performance. Our findings are consistent with the AICPA's and financial analysts' rationale for their recommendation that the financial effects of a company's core and non-core cash flows should be distinguished. We also corroborate prior research that both direct and indirect methods of reporting cash flows can be useful for assessing future cash flows. Our findings are relevant to financial statement users and regulators who are interested in better predicting future cash flows and researchers using cash flow prediction models to measure financial reporting quality.

Keywords: Cash Flows, Cash Flow Prediction, Cash Flow Persistence, Core Cash Flows, Cash Flow Variability

JEL Classification: G29, M41