Accruals and the prediction of future cash flows

Building on the Dechow et al. (1998) model of the accrual process, this stu dy investigates the role of accruals in predicting future cash flows. The m odel shows that each accrual component reflects different information relat ing to future cash flows; aggregate earnings masks this information. As pre dicted, disaggregating accruals into major components-change in accounts re ceivable, change in accounts payable, change in inventory, depreciation, am ortization, and other accruals-significantly enhances predictive ability. E ach accrual component, including depreciation and amortization, is signific ant with the predicted sign in predicting future cash flows, incremental to current cash flow. The cash flow and accrual components of current earning s have substantially more predictive ability for future cash flows than sev eral lags of aggregate earnings. The inferences are robust to alternative s pecifications, including controlling for operating cash cycle and industry membership.