Review of Accounting Studies

, Volume 15, Issue 4, pp 779–807 | Cite as

The usefulness of accounting estimates for predicting cash flows and earnings

  • Baruch LevEmail author
  • Siyi Li
  • Theodore Sougiannis


Accounting estimates and projections potentially improve the relevance of financial information by providing managers a venue to convey to investors forward-looking, inside information. The quality of financial information is, however, compromised by the increasing difficulty of making reliable estimates and forecasts and the frequent managerial misuse of estimates. Given the ever-increasing prevalence of estimates in accounting data, particularly due to the move to fair value accounting, whether these opposing forces result in an improvement in the quality of financial information is among the most fundamental issues in accounting. We examine the contribution of accounting estimates embedded in accruals to the quality of financial information, as reflected by their usefulness in the prediction of enterprise cash flows and earnings. Our out-of-sample prediction tests indicate that accounting estimates beyond those in working capital items (excluding inventory) do not improve the prediction of cash flows. Estimates do, however, improve the prediction of next year’s earnings, though not of subsequent years’ earnings. We conclude that the usefulness of accounting estimates to investors is limited and provide suggestions for improving the usefulness of estimates.


Accounting estimates In-sample prediction Out-of-sample prediction Earnings Cash flows 

JEL Classification

G10  M41 



The authors are indebted to the editor and reviewers of the Review of Accounting Studies for comments and suggestions and to Louis Chan, Ilia Dichev, John Hand, James Ohlson, Shiva Rajgopal, and Stephen Ryan for helpful comments, as well as to participants of seminars at Athens University of Economics and Business, London Business School, Penn State University, Purdue University, University of Illinois at Urbana-Champaign, University of Texas at Dallas, Washington University in St. Louis, the joint Columbia–NYU Seminar, the 16th Financial Economics and Accounting Conference, the 2006 AAA FARS Midyear Meeting, the 2007 Hellenic Finance and Accounting Association Conference, and the 2008 AAA Annual Meeting.


  1. Abarbanell, J., & Bushee, B. (1998). Abnormal returns to a fundamental analysis strategy. The Accounting Review, 73, 19–45.Google Scholar
  2. Aboody, D., & Lev, B. (1998). The value-relevance of intangibles: The case of software capitalization. Journal of Accounting Research, 36, 161–191.CrossRefGoogle Scholar
  3. Barth, M., Beaver, W. H., Hand, J. R. M., & Landsman, W. R. (2005). Accruals, accounting-based valuation models, and the prediction of equity values. Journal of Accounting, Auditing & Finance, 20(Fall), 311–345.Google Scholar
  4. Barth, M., Cram, D., & Nelson, K. (2001). Accruals and the prediction of future cash flows. The Accounting Review, 76, 27–58.CrossRefGoogle Scholar
  5. Barth, M., Elliott, J., & Finn, M. (1999). Market rewards associated with pattern of increasing earnings. Journal of Accounting Research, 37, 387–413.CrossRefGoogle Scholar
  6. Bathke, A. W., Lorek, K. S., & Willinger, G. L. (1989). Firm-size and the predictive ability of quarterly earnings data. The Accounting Review, 64, 49–68.Google Scholar
  7. Bowen, R. M., Burgstahler, D., & Daley, L. A. (1986). Evidence on the relationships between earnings and various measures of cash flow. The Accounting Review, 61, 713–725.Google Scholar
  8. Campbell, J., Lettau, M., Malkiel, B., & Xu, Y. (2001). Have individual stocks become more volatile? An empirical exploration of idiosyncratic risk. Journal of Finance, 56, 1–43.CrossRefGoogle Scholar
  9. Collins, D., & Hribar, P. (2002). Errors in estimating accruals: Implications for empirical research. Journal of Accounting Research, 40(1), 105–134.CrossRefGoogle Scholar
  10. Dechow, P., Sloan, R., & Sweeney, A. (1996). Causes and consequences of manipulation: An analysis of firms subject to enforcement actions by the SEC. Contemporary Accounting Research, 13, 1–36.CrossRefGoogle Scholar
  11. Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. The Journal of Finance, 47(2), 427–455.CrossRefGoogle Scholar
  12. Fama, E., & MacBeth, J. (1973). Risk, return and equilibrium: Empirical tests. Journal of Political Economy, 81, 607–636.CrossRefGoogle Scholar
  13. FASB. (1978). Statement of financial accounting concepts no. 1: Objectives of financial reporting by business enterprises. Stamford, CT: Financial Accounting Standards Board.Google Scholar
  14. Finger, C. (1994). The ability of earnings to predict future earnings and cash flows. Journal of Accounting Research, 32, 210–223.CrossRefGoogle Scholar
  15. Greenberg, R. R., Johnson, G. L., & Ramesh, K. (1986). Earnings versus cash flows as a predictor of future cash flows. Journal of Accounting, Auditing and Finance, 1, 266–277.Google Scholar
  16. Ijiri, Y. (2002). Cash is a fact, but income is a forecast. Working paper, Carnegie Mellon University.Google Scholar
  17. Kim, M., & Kross, W. (2005). The ability of earnings to predict future operating cash flows has been increasing-not decreasing. Journal of Accounting Research, 43(5), 753–780.CrossRefGoogle Scholar
  18. Lev, B., & Nissim, D. (2006). The persistence of the accruals anomaly. Contemporary Accounting Research, 23, 193–226.CrossRefGoogle Scholar
  19. Lev, B., Ryan, S., & Wu, M. (2008). Rewriting earnings history. Review of Accounting Studies, 13, 419–451.CrossRefGoogle Scholar
  20. Lev, B., & Zarowin, P. (1999). The boundaries of financial reporting and how to extend them. Journal of Accounting Research, 37, 353–385.CrossRefGoogle Scholar
  21. Lorek, K. S., Schaefer, T. F., & Willinger, G. L. (1993). Time-series properties and predictive of funds flow variables. The Accounting Review, 68, 151–163.Google Scholar
  22. Lorek, K. S., & Willinger, G. L. (1996). A multivariate time-series prediction model for cash-flows data. The Accounting Review, 71, 81–101.Google Scholar
  23. Lundholm, R. (1999). Reporting on the past: A new approach to improving accounting today. Accounting Horizons, 13, 315–323.CrossRefGoogle Scholar
  24. Ou, J., & Penman, S. (1989). Financial statement analysis and the prediction of stock returns. Journal of Accounting and Economics, 11, 295–329.CrossRefGoogle Scholar
  25. Piotroski, J. (2000). Value investing: the use of historical financial statement information to separate winners from losers. Journal of Accounting Research, 38, 1–41.CrossRefGoogle Scholar
  26. Poon, S., & Granger, C. (2003). Forecasting volatility in financial markets. Journal of Economic Literature, XLI, 478–539.CrossRefGoogle Scholar
  27. Sloan, R. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71, 289–315.Google Scholar
  28. Stober, T. (1992). Summary financial statement measures and analysts’ forecasts of earnings. Journal of Accounting and Economics, 15, 347–372.CrossRefGoogle Scholar
  29. Subramanyam, K., & Venkatachalam, M. (2007). Earnings, cash flows and ex post intrinsic value of equity. The Accounting Review, 82, 457–481.CrossRefGoogle Scholar
  30. Thomas, J., & Zhang, H. (2002). Inventory changes and future returns. Review of Accounting Studies, 7, 163–187.CrossRefGoogle Scholar
  31. Zion, D. (2002). The magic of pension accounting, Credit Suisse First Boston.Google Scholar

Copyright information

© Springer Science+Business Media, LLC 2009

Authors and Affiliations

  1. 1.Stern School of BusinessNew York UniversityNew YorkUSA
  2. 2.Department of AccountancyUniversity of Illinois at Urbana-ChampaignChampaignUSA
  3. 3.Athens Laboratory of Business Administration (ALBA)VouliagmeniGreece

Personalised recommendations