ABSTRACT

Sloan (1996), Richardson et al. (2005, 2006) examine firms’ accruals relation to subsequent financial performance. They identify a negative correlation and attribute it to accruals lack of reliability. This paper considers the issue from a different starting point: we forecast sales and expenses separately and argue on prior grounds that accruals are generally informative about their changes. Two accruals variables serve as the primary predictors, year-to-year changes in operating assets and operating liabilities. This framework thus implies 2 forecasting equations, the RHS of each comprising 2 accrual variables, plus controlling variables.  To derive the 2x2 load-factors’ expected relative magnitudes we apply traditional accounting constructs. Further, this framework leads to the hypothesis that accruals have a negative effect on the expected ROA and earnings, consistent with the literature. While these findings support the accruals’ negative effects hypothesis, a closer look shows refinements. First, liability accruals are notably more informative than asset accruals. Second, while both accrual variables forecast ROA robustly, results are weaker when the forecasting shifts to earnings. Third, the 2 accrual variables are more informative in case of smaller firms. The empirics also bring out differences between operating accruals versus changes in financial assets and liabilities.