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On the Analysis of Firms' Cash Flows

Ohlson, James A.; Aier, Jagadison K.

This paper revisits the whys and hows of cash flows analysis. The analysis maintains a strict common shareholders' perspective with an equity valuation focus. The paper argues that analysts turn to cash flows to evaluate the potential ambiguity inherent in accruals. The GAAP statement of cash flows, however, (i) relies on a too narrow concept of cash and (ii) lacks a clear bottom-line directly comparable to net income per GAAP. To circumvent (i) and (ii), the paper proposes a framework of Modified Cash Accounting (MCA). A MCA statement of cash earnings satisfies a crucial property: It works like a regular income statement yet eschews all accruals. The paper discusses not only how one motivates and develops a MCA statement of cash earnings, but also how it should be put to use. A crucial issue deals with how one compares the two bottom-lines -- GAAP income vs. that of MCA cash earnings -- given alternative growth scenarios. The paper shows how one can estimate a "normal accrual," which can be added to MCA cash earnings, given assumptions about the firm's growth.

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More About This Work

Academic Units
Center for Excellence in Accounting and Security Analysis
Publisher
Columbia Business School, Center for Excellence in Accounting and Security Analysis
Series
Center for Excellence in Accounting and Security Analysis Occasional Paper Series
Published Here
April 5, 2010
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