Are Cash Flow Forecasts issued with Earnings Estimates when Earnings Quality is low

This study examines the recent trend of analysts issuing cash flow forecasts to complement their earnings estimates.

Cash flows are incrementally useful to earnings in security valuation mainly when earnings quality is low. This suggests that when earnings quality decreases, analysts are more likely to supplement their earnings forecasts with cash flow estimates. However, contrary to this prediction, we find that analysts do not disclose cash flow forecasts when the quality of earnings is low. This is because cash flow forecast accuracy depends on the accuracy of the accrual estimates and the precision of accrual forecasts decreases for firms with low quality earnings. Consequently, as earnings quality decreases, cash flow forecasts become increasingly inaccurate compared to earnings estimates. Cash flow estimates that lack reliability are not useful to investors and, consequently, are unlikely to be reported by analysts. This provides an explanation for why analysts are less likely to report cash flow estimates when earnings quality is low.

The full working paper can be downloaded at the link below.