Are earnings better than cash flows at predicting future cash flows? Evidence from apples-to-apples comparisons

Abstract

We compare the abilities of earnings and cash flows to predict future cash flows. We take a novel approach in that we perform apples-to-apples comparisons of five earnings components measured on an accrual basis with their equivalents measured on a cash basis. On the one hand, we find that the operating profit component (sales net of cost of goods sold and SG&A expense) outperforms its cash-basis equivalent in predicting future cash flows. On the other hand, we find that the depreciation expense and non-operating income components underperform their cash-basis equivalents in predicting future cash flows. Additionally, we fail to find significant differences between the predictive abilities of the interest expense and income tax expense components and their cash-basis equivalents. The inconsistent findings across earnings components suggest that unequivocal all-or-nothing conclusions on the relative predictive abilities of earnings and cash flows are unwarranted.