A Comparison of the Effectiveness of the Operating Funds Flow Measures of Cash, Net Quick Assets, and Working Capital in Predicting Future Cash Flow.

In Statement of Financial Accounting Standards No. 95, Statement of Cash Flows, the Financial Accounting Standards Board requires a statement of cash flows in place of a statement of changes in financial position. This information is assumed to be useful in predicting future cash flow. The first part of this three-part study empirically tests this assumption by comparing the abilities of three operating funds flow measures (working capital, net quick assets, and cash) to predict future cash flows. The second part of this study determines whether the reporting concept best for predicting future cash flow is dependent upon industry classification. The third part examines whether differences in the abilities of the three operating funds flow measures to predict future cash flow are affected by differences in the components of the current assets and current liabilities of a firm. Data for 454 firms were obtained from Compustat for the ten-year period from 1976-1985. Variables examined in the study included the three operating funds flow measures as independent variables and one dependent variable, future cash flow from operations. A cross-sectional, time series regression model was used in each of the three parts of this study. In the first part, each independent variable was tested by using all of the firms in three separate regression analyses. In the second part of the study, the firms were grouped according to industry classification. Each industry was tested with three separate regression analyses. In the third part of the study, the firms were grouped by cluster analysis according to similarities in the composition of their current assets and current liabilities. The resulting four clusters were each tested separately by using three regression analyses. Results of tests of the first part of this study indicated that working capital from operations is the best predictor of future cash flow. Results of tests of the second part of this study indicate that the effectiveness with which each of the operating funds flow measures predicts future cash flow varies across industries. Results of tests of the third part of this study were inconclusive