Literature Review On Financial Management

This study relates to examine the relationship of cash flow from operations, earning and sales with share price and the previous research has predicted the comparative abilities of cash flow, earning and sales but this study is only concerned with the relationship of cash flow, earning and sales with share price.In the finance literature that market forces determine share price equal to the discounted value of a stream of expected future cash flows (Hollister et al., 2002).Disclaimer: This work has been submitted by a student.

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An exception to this general result is that net income plus depreciation and amortization and working capital from operations appear to be the best predictors of cash flow from operations.

Overall there results are not consistent with the FASB’s statements that earnings numbers provide better forecasts of future cash flows than do cash flow numbers.

The random walk provides better out-of-sample forecasts than do individually estimated models one year ahead for 52% of the sample firms, Out of sample forecasts show that random walk models outperform individually estimated earnings models for one-year but not for four- or eight-year horizons.

Earnings, used alone and with cash flow, are a significant predictor of cash flow for the majority of firms.

This results in larger estimation errors for accruals and diminished earnings quality.

It gives an idea about how monthly sales announcements of major department and discount stores provide information for investors not only for the retail giants but also for their suppliers (Olsen and Dietrich (1985).I use time-series methods to test firm-specific predictive ability over the entire time period (hereafter in-sample regression tests) and then compare out-of-sample forecast errors to assess earnings’ ability to improve earnings or cash flow forecasts up to eight years ahead.He found that earnings are a significant predictor of future earnings, in sample, for 88% of the firms.Cash flows represent amounts investors expect to receive in the form of dividend payments or from the sale of their shares and not necessarily the annual operating cash flows generated by a firm.Consequently, it is in a very broad sense that share price is considered to embody a firm’s future cash flows.It has been shown that earnings better predicts future operating cash flows than does current operating cash flows because accruals in earnings “offset the negative correlation in cash flow changes to produce earnings changes that are much less negatively serially correlated ( Dechow, et al 1998) that is why earnings, rather than current operating cash flows, tends to be used in firm share valuations.Earnings quality can be affected by sales volatility (Dechow and Dichev (2002) and Francis et al. By and large the greater the sales volatility, the more unstable is the operating environment.It was concluded that the study provides evidence in support of the FASB’s assertions that current earnings is a better predictor of future cash flows than is current cash flows. Rivara(1996) found out the accuracy and the consensus among forecasters of earnings estimates for U. (Ball and Watts (1972), Albrecht, Lookabill & Mc Keown (1977), Watts and Leftwich (1977) and Lev (1983) studied the Earnings ability to predict future earnings studied first or second order autocorrelations and or forecasts over one or two-year horizons and provided evidence to support a random walk model that is uncorrelated earnings changes, However, random walk may not be descriptive of the earnings process Where as Ramesh and Thiagarajan (1989) rejected a random walk earnings model and Lipe and Kormendi (1993) show that higher order, rather than random walk, models are descriptive of market-adjusted earnings’ time-series process.Finger (1994) found out the earnings ability to predict future earnings and future cash flow from operations1 one through eight years ahead using annual data from1935-87 for 50 firms.R square for the earnings and cash flows model were compared and the model with the higher R square was determined to be the better predictor. multinational corporations, it was observed that the accuracy of earnings forecasts is significantly lower for purely domestic firms than for U. Like wise the level of consensus in earnings estimates submitted by financial analysts is significantly lower for U. These improvements go beyond separating extraordinary items and discontinued operations from the other components of earnings.The results showed that earnings outperformed CFFO in predicting future CFFO. Further disaggregation of earnings (into operating earnings, non-operating earnings and taxes, and special items) improves forecasts of ROE one year ahead.