The comparative predictive abilities of accrual earnings and cash flows in periods of economic turbulence: The case of the IT bubble

Abstract

As set forth in SFAC No. 1, a primary objective of financial reporting is to provide information useful to decision makers. Predicting future cash flows represents a major goal of investors and creditors, and accrual and cash flow accounting information present two alternative factors useful in such predictions. The current research investigates the comparative abilities of accrual basis net income and historical cash flows from operations as predictors of future cash flows during both the economic boom leading up to the IT Bubble and the period of economic duress following the burst of that Bubble. Generally, results indicate that historical cash flows outperform accrual net income in predicting future cash flows during these periods of economic turbulence. Additionally, the evidence reveals great variability in the predictive ability of accrual earnings during the time period studied, suggesting that accrual accounting estimates lose some of their precision during periods of extreme economic fluctuation.