Relationships between earnings and measures of cash flow : Australian evidence / by Majella Percy.

Overseas research suggests that operating cash flows may be an important component in firm valuation decisions. This study aims to provide evidence of the relationships between earnings and cash flow measures to investigate whether the findings of the U.S.A. study by Bowen, Burgstahler and Daley [1986] are generalisable to Australian companies and to industry classifications of companies. Evidence is presented first that shows low correlations between traditional cash flow measures (i.e. operating profit plus depreciation and amortisation and working capital from operations) and a more refined cash flow measure. Second, traditional cash flow measures exhibit high correlations with earnings, while a more refined cash flow measure has a lower correlation with earnings. Finally, traditional cash flow measures better predict future cash flows than models based on earnings or a more refined cash flow measure. The industry evidence provided suggests the results are generalisable across industry categories. Overall, the results enhance the external validity of the findings from the earlier study.