The impact of size and source of nonarticulation on the information content of reported cash flows from operations.

Abstract

Early research into the information content of operating cash flows relied on estimates derived from information in the income statement and changes in balance sheet items. Since 1988 firms have been required to present a statement of cash flows with their annual reports. In many cases, the reported value is quite different from the estimate. Prior studies have suggested that the main reasons for this nonarticulation include acquisitions, dispositions and foreign currency adjustments. In this paper I test whether reported cash flow from operations has incremental information content given estimated cash flows from operations and earnings and find that the nonarticulation does contain information for valuation. Testing whether the magnitude of nonarticulation is informative I find some evidence that reported cash flow from operations provides less information when nonarticulation is large. I also find that reported cash flow from operations contains less information content when firms experience acquisitions but is more informative when foreign currency adjustments are present. Unfortunately, the proposed sources are weak in explaining the magnitude of the nonarticulation. Another reason reported and estimated cash flow from operations may differ is misclassification of cash flows between operating, investing and financing activities. I find that the market places higher value on operating cash flows relative to investing and financing, creating an incentive for managers to opportunistically choose cash flow classifications which would exacerbate the nonarticulation problem.