Comparison of the abilities of historical and current cost information to predict funds flows

This study compared current operating income (COI), current operating income plus realizable holding gains measured in constant dollars and purchasing power gain (i.e., current real income (CRI)), and historical cost income measured in nominal dollars (HCI) on their ability to predict future funds flows from operations of the business firm. Three different definitions of funds flows used were working capital from operations (WCFO), net current monetary assets from operations (NCMAFO), and cash flow from operations (CFO). It was hypothesized that since COI reflected more current input prices, the COI measurements would predict funds flow from operations better than the HCI measurements as long as input price changes were not cyclical. Additionally, holding gains/losses would mean future increasing/decreasing operating flows to the degree that input price changes could be passed along to consumers without drastically affecting sales volume. In this case, the CRI measurements would have the potential to be better predictors of funds flows than the others. Since industry differences would affect current cost versus historical cost measurements as well as a firm's ability to pass along price changes, industry classification would have an effect on the funds flow prediction. A repeated measures analysis of variance method was employed in the analysis of prediction errors. Four factors considered were the industry classification, year, income method, and predictor model. It was concluded that all four factors generally had effects on prediction. In addition, the predictive ability comparisons among the income measurement methods were different depending on the specific funds flow definition used. In predicting WCFO and CFO, the HCI and CRI measurements were better predictors than the COI measurements, and there was no significant difference between the HCI and CRI measurements. In predicting NCMAFO, the CRI measurements were the best, and the COI measurements were the least accurate. The predictive ability comparisons for each industry classification separately produced mixed results