Abstract
Cash flow from operations can be considered an important indicator of the quality of income of a company. The value of cash flow data was emphasized by Ismail Kim who found that cash-flow-based accounting betas have significant incremental explanatory power over earnings-based betas in explaining the variability in market risk. In this article similar research is reported which was conducted on a sample of companies extracted from the Industrial Section of the Johannesburg Stock Exchange and using the methodology proposed by Ismail Kim. A three year moving average smoothing procedure was also applied to the accounting return variables in order to reduce the effect of short-term influences on the cash flow. Although it was not possible from the research to obtain similar statistically significant results for the South African market (partly because of the relatively small sample size), it was found that the simple linear regression model based on the smoothed cash flow beta did provide significant explanatory power of the variability in market beta.
Highlights
During periods of high inflation a closer focus on corporate cash flow management may well be warranted
A major issue of concern in this research was the relatively small size of the available sample. This contributed to the non-significance of the multiple regression models, as the relatively small data vectors are more severely affected by variability of the data components
The results obtained from the analysis showed that a significant portion of the variability in market risk could be explained by the variability in the smoothed cash flow-based accounting betas
Summary
During periods of high inflation a closer focus on corporate cash flow management may well be warranted. The effect of inflation on financial statements can be substantial, and rising costs, an increase in invesunent in working capital and the increasing cost of replacing fixed assets are all factors that place an increasing burden on cash flow. Cash flow information tends to be masked by accounting allocations in the financial statements. In South Africa, double digit inflation coupled to substantial swings in the business cycle emphasizes the need for cash flow information and management ljiri (1980) and Drtina & Largay (1985) found that it was difficult to determine actual cash flows from published data. Prior to the disclosure of cash flow data it could have been difficult for investors to accurately identify the relevant cash flow effects from published accounting data. In an attempt to determine the value of estimated cash flow data, Ismail & Kim (1989) found that cash flow-based accounting betas contained significant incremental explanatory power over earnings-based betas in describing the variability of market risk
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