Investigating the relationship between operating cash flow and accruals components on predicting future profits of companies listed on the Tehran Stock Exchange.

Dissertation for Master's Degree in Accounting

Accounting Orientation

Abstract

The informational content of profit has been widely tested in accounting and finance texts. Since in most cases, including financial reporting and evaluation models, profit plays a fundamental role, it is very important to determine financial items and variables related to accounting profit for the purpose of forecasting.

The purpose of this research is to examine the relationship between operating cash flow and components of accruals on predicting the future profit of companies listed on the Tehran Stock Exchange. To evaluate and calculate components of accruals, modified Jones method has been used. The studied time period is from 1386 to 1391 and the selected sample includes 123 companies. Three hypotheses were designed to examine the research topic and the regression statistical method was used to test them. In this research, optional components of accruals (DA), non-optional components of accruals (NDA) and operating cash flow (OCF) were considered as independent variables and future operating profit as a dependent variable. The results of this research indicate that among the optional components of accruals for the current period, Accrual items of the current period and operating cash flow have a direct and meaningful relationship with the operating profit of the future period.

Key words:

Accrual items - optional components of accrual items - non-optional components of accrual items - operating cash flow

Introduction

One of the most important financial information reported by any company is the profit of the company. In fact, investors and many other financial users consider accounting profit as an important source of information that allows them to estimate the real performance of the company and make decisions based on it. Given that accounting profit is a tool in the hands of management, in some cases, accounting profit may not show an accurate picture of a company's performance, and due to the use of related judgments and estimates, there is a need to provide additional information to increase its information usefulness. Cash flow and accruals can provide users with additional information about economic performance and accounting profit. Shareholders, who are the most important group of financial statement information users, look for their interests in profit information. Accounting profit is a sign that changes the beliefs and behavior of investors. The quality of profit can affect investors' confidence in financial markets in financial reporting. Among the important factors affecting the quality of profit, we can mention multiple accounting methods, inadequacies in the process of estimations and forecasts, discretion of managers, and the impact of profit on the basis of reporting and managers' discretion. The term profit quality refers to the ability of managers to use discretionary items in profit measurement and reporting. Optional items may include choosing among accounting principles or standards and using estimates and timing of transactions to identify unusual items in profit.

1-1- Introduction

One of the most important financial information reported by any company is the profit of the company. In fact, investors and many other financial users consider accounting profit as an important source of information that allows them to estimate the real performance of the company and make decisions based on it. Given that accounting profit is a tool in the hands of management, in some cases, accounting profit may not show an accurate picture of a company's performance, and due to the use of related judgments and estimates, there is a need to provide additional information to increase its information usefulness. Cash flow and accruals can provide users with additional information about economic performance and accounting profit. Shareholders, who are the most important group of financial statement information users, look for their interests in profit information. Accounting profit is a sign that changes the beliefs and behavior of investors.The quality of profit can affect investors' confidence in financial markets in financial reporting. Among the important factors affecting the quality of profit, we can mention the numerous accounting methods, the inadequacies in the process of estimates and forecasts, the discretion of managers and the impact of profit on the basis of reporting and the discretion of managers. The term profit quality refers to the ability of managers to use discretionary items in profit measurement and reporting. Optional items may include choosing among the accounting principles or standards and using estimates and timing of transactions to identify unusual items in profit. 1-2-Statement of the problem Forecasting the cash flow of operations and its changes as an economic event has long been of interest to researchers, investors, managers, financial analysts and creditors. This attention is due to the use of operating cash flows in stock valuation models, assessment of solvency (dividends, interest and other obligations), risk assessment, evaluation of economic unit performance and management stewardship, evaluation of how management chooses accounting methods, and the use of operating cash flows to make beneficial decisions related to decision-making models. Now, if it is possible to predict the flow of operating cash in a proper way, a significant part of the information needs related to the flow of cash will be provided.  The primary purpose of financial reporting is to provide information that helps investors assess the amount, timing, and risk of future cash flows. However, the information that is most useful in evaluating future cash flows is controversial. Some analysts and investors claim that operating cash flow is the main evaluation measure. For example, Copeland et al. (1990) believe that although traditional accounting criteria can be a useful tool for understanding and knowing the performance of operating cash flow, these traditional criteria cannot replace direct indicators such as cash flow. On the other hand, some accountants believe that profit is the main source of information. For example, in Concept Statement No. 1 of the Financial Accounting Standards Board (FASB), it is stated that information related to profit better than cash flow information, provides the interests of investors in predicting the future cash flows of a business entity. (Goldberg and Kim, 2001) Many financial analysts and investors believe that cash flow measures, including free cash flows, are very useful when assessing a company's financial health and prospects. Free cash flow is important from this point of view as it allows managers to look for opportunities that increase the value of the company's stock. It is not possible to develop new products, carry out business studies, pay cash dividends to shareholders and reduce debts without having cash available. In the present research, the issue of whether accrual items and operating cash has the ability to predict profits is examined. 1-3- Importance of the issue, The circulation of operating cash and accruals is not a secret for investors. Profit is one of the most important indicators for measuring the performance of an economic unit. Researchers and researchers have explained its different approaches in the framework of scientific findings, measured the strengths and weaknesses of the perceptions and, with effort, have increased its accuracy and capabilities. Investors have a special place in mind for accounting profit as a forecasting tool. Also, stock returns are linked with the expected profit flow and the investor is usually based on his expectations of the company's profit and Accordingly, the dividend (cash profit) is used to keep or sell shares. Cash dividends (dividends) are the most common distribution of returns through companies to shareholders, but companies do not act in the same way in distributing their cash dividends and adopt different policies. These policies can include a range from not paying cash dividends to paying all the company's earnings. Since profit is a tool in the hands of the company's management, and net profit is also a direct variable for calculating management salaries and bonuses, it is subject to manipulation. Therefore, sufficient cash funds to meet the needs of management and investors depends on the presence of positive operating cash flow, and also provides the ability to predict the increase in profit through operating cash flow and components of accrual items.