Analysts’ perceptions of cash flow reporting: earnings reliability, confidence and implications for evaluating firm performance

Abstract

PurposeThis study aims to provide insights into US and Australian analysts' views regarding the relative importance of disclosing the direct method (DM) or indirect method (IM) statement of cash flows and forecasting firm performance.Design/methodology/approachEvidence is collected from responses to 104 surveys and 52 interviews completed by US and Australian analysts from 2017 to 2022. The survey and interview questions are developed with reference to the literature.FindingsUS and Australian analysts believe that the DM format provides incremental benefits compared to the IM for (1) confirming the reliability of earnings; (2) improving earnings confidence; (3) more accurateex anteforecasts of operating cash flow and earnings; and (4) identifying opportunistic accruals manipulation. Analysts view that DM disclosure can lower firm-level cost of equity, although US interviewees more uniformly expect lower costs of equity under DM disclosure when firms yield low earnings quality. DM disclosure is also more important during unstable economic periods, as proxied by COVID-19.Originality/valueLimited research currently exists regarding disclosure of the DM or IM and its impact on analysts' forecasting accuracy, earnings quality, economic uncertainty and cost of equity. Previous research has relied on archival research to examine differences between the DM and IM methods and are limited by data availability. Our findings are particularly relevant to the US market with few US firms reporting the DM format.