Usefulness of financial statement components in valuation: An examination of start-up and growth firms

Abstract

According to US financial accounting standards and prior research, accrual-based earnings provide the best measure of firm performance. Results from prior capital markets research imply that earnings are more value-relevant than operating cash. There are, however, potential problems in pooling cross-sectionally across all firms and assuming a homogeneous sample of companies. For many start-up and early growth companies, their earnings are non-positive. Other components of the financial statements may be more value-relevant than the bottom-line earnings. In early firm life cycle stages, growth opportunities are a relatively larger component of firm value than assets in place; in these stages, the proxy that provides more value-relevant information about firm-value is the one that provides more information about the future growth opportunities of the firm. This study examines both the incremental and relative usefulness of earnings, cash flow and book value financial statement components using various valuation models. Results indicate that earnings do not provide significant information for valuation of start-ups, but become incrementally informative as firms move into a growth stage. Other financial statement components, particularly cash flow measures, are relatively more value-relevant than earnings in these early stages of a firm's existence. These results have implications for researchers, analysts, investors and management.