Predictive Power of Accounting Estimated: Empirical Evidence from Indonesia

Abstract

This study examines the ability of accrual components estimated by managers in predicting firm performance which is represented by cash flow and earnings. To confirm my findings, I extend the classification of cash flow in to two groups which are cash flow from operation and free cash flow while earnings are divided into net income and operating income. The investigation is designed to forecast 1 year and 2 years ahead using the data from 3 sectors : raw material, processing, and service companies listed in the Indonesian Stock Exchange spanning from 1997 to 2012. In addition, I investigate the usefulness of these components by testing whether they can provide abnormal returns. The findings show that the accrual components estimated by managers have additional power in forecasting cash flow from operation and free cash flow in one and two years ahead. Meanwhile, it also giveห additional power in forecasting operating income in one year ahead and net income in two year ahead. Moreover, by considering the accrual components estimated by managers in making investment decisions, it is able to provide the abnormal return in the case of forecasting free cash flow only.