Financial Distress, Analyst Cash Flow Forecasts And The Manipulation Of Operating Cash Flow

Cash from operations and earnings are two complementary measures of firm performance. Earnings are calculated on the Accrual Basis, so the items on the financial report are affected by accounting estimates and accounting policy choices. It is possible that earnings are not dependable. Cash from operations is calculated on the cash basis of accounting. Operating cash flows reflects the results of transactions that are sustainable. Operating cash flow is renewable, dependable and ongoing, without the interfering of accruals, amortization and deferred items. So it is thought that cash from operations is more reliable than earnings. Recent studies document that a growing and significant proportion of firms’are manipulating cash from operations to inflate the performance. It is concerned that managers exercise discretion in financial reporting to manipulate cash from operations. This study examines the manipulation of cash from operation, and try to find in certain circumstances, whether the managers have the incentives to inflate the operating cash flow.First, this study makes a summary of the related literature about the manipulation of cash from operation, and class the prior literature into three categories. They are study of the existences of operating cash flow manipulation, study of the incentives and mechanisms of operating cash flow manipulation, study of the effect of real activities manipulation on operating cash flow. It seems that limited research have been made about the relationship of analyst cash flow forecasts, financial distress and operating cash flow manipulation.Then, this study discusses the relationship of analyst financial distress, cash flow forecasts and operating cash flow manipulation in a logistic way. Based on the relationship I develop the three Hypotheses. I use the Roychowdhury model to classify the operating cash flow into expected and unexpected categories, use the LMP model to calculate the probability of financial distress, and calculate the discretionary accruals by the modified Jones model. After the logistic regressions of all the data adopted, the hypotheses are tested and proved. With the existence of the analyst cash flow forecasts, managers are likely to inflate the operating cash flow. The more the firms are going to be in financial distress, the more likely the managers to inflate the operating cash flow. The two characteristics have a cross effect and enhance each other. The evidence is convincing.At last, this study made some suggestions for different stakeholders, and summarized the contributions, caveats and future research metrics.