Cash Flow, Earning Opacity and its Impact on Stock Price ...

1 International Journal of Academic Research in Accounting, Finance and Management Sciences Vol. 3, No. 4, October 2013, pp. 138 145 E-ISSN: 2225-8329, P-ISSN: 2308-0337 2013 HRMARS cash flow , Earning Opacity and its Impact on Stock Price Crash Risk in Tehran Stock Exchange Hossein JABBARI1 Zeinolabedin SADEGHI2 Seyed Ali ASKARI3 1 Islamic Azad University of Kashan, Kashan, Iran, E-mail: 2 Shahid Bahonar University of Kerman, Kerman, Iran, E-mail: 3 Kerman Science and Research branch, Islamic Azad University, Kerman, Iran, E-mail: (Corresponding author) Abstract This study examined the role of operating cash flow and its ability in predicting and reducing Stock Price crash risk.

2 The aim of this study was to investigate efficacy of operating cash flow on predicting and detecting Stock Price crash risk and also investigating role of operating cash flow on Earning Opacity in companies. The research methodology was of survey-explorative correlation type and the data were gathered using library method. The statistical population included companies accepted in Tehran Stock Exchange during 2006 to 2010, from which the sample was selected. Also, regression and correlation coefficients were used to examine correlation degree and relationship direction of the variables.

3 The research results indicated a significantly inverse relationship between operating cash flow and Stock Price crash risk. Moreover, a significantly inverse relationship existed between operating cash flow and Earning Opacity ; the higher the operating cash flow , the lower the Earning Opacity . Key words cash flow , Earning Opacity , Stock Price crash risk, Tehran Stock Exchange DOI: URL: 1. Introduction The main purpose of preparing financial statements is to present information which is needed for investors and users in financial decisions. The first step in investment decisions is to obtain Stock value of the companies in which investors have invested or intend to invest.

4 One of the most important issues which have been always considered by the participants in financial markets such as stocks has been Stock value, which depends on Earning of the company and its operating cash flow . Today's views on financial theories indicate that value of a company can be judged by its cash flow . Accounting Earning alone cannot provide appropriate information for investors because of being based on accrual method of accounting profit and following accounting principles and assumptions. Therefore, it can be easily affected by managers' choices and actions. In contrast, cash flow is more subjective and less affected by managers' actions.

5 Results of various studies have indicated that cash flows contain more information content and thus higher efficacy on decisions of investors. However, researches which have been done so far have had more concentration on relative and incremental information content of cash flows and less focus on information content of operating cash flow and its role in Earning Opacity and Stock Price . This study tried to examine the following fundamental question: Does cash flow have an Impact on Stock Price crash risk or not? International Journal of Academic Research in Accounting, Finance and Management Sciences Vol.

6 3 (4), pp. 138 145, 2013 HRMARS 139 2. Literature review Objectives of cash flow statement In the first clause of Iranian Accounting Standard, the objective of cash flow statement is as follows: Historical information related to cash flow can help users of financial statements in judging time, amount and actualization reliability of future cash flows . The mentioned data indicate manner of the relationship between profitability of business unit and its ability for generating cash and thus indicates quality of the Earning obtained by that business unit. In addition, analysts and other users of financial information often use models either formally or informally to assess and compare present value of future cash flows of business units.

7 Historical information of cash flow can be useful for controlling accuracy of past evaluations and showing the relationship between activities of business unit and its receipts and payments (Iranian Accounting Standards, 2006, No. 2, clause 1). This standard also states that balance sheet; statements of financial performance and statement of cash flow altogether provide information about financial status, financial performance, liquidity and ability to repay debts and financial flexibility. Thus, it is essential to establish a relationship between the information recorded in statement of cash flow and information presented in other basic financial statements (Iranian Accounting Standards, 2006, No.)

8 2, Clause 2). Although statement of cash flow provides information about cash flow of business unit during the reported financial period, these data are not adequate for evaluating future cash flow . Some cash flows result from transactions that have occurred in previous financial periods and are sometimes expected to result in other cash flows in one of the future periods. Therefore, for the assessment of future cash flows , financial statements of cash flow should be usually used along with financial performance statements and balance sheet (Iranian Accounting Standards, 2006, No.

9 2, Clause 3). Therefore, the main aim of cash flow statements is to provide information about cash receipts and cash payments of an institution during a financial period (the term cash flows include the cash that is received and paid). In addition, cash flow statement also reflects all the information related to investment activities and financing the institution during a financial period. Review of historical background of cash flows Until about 1930s, financial statements were prepared on the basis of cash. Until then, Earning was determined based on cash flows and, since accounting standards became widespread, financial reporting was established based on accrual accounting.

10 Accrual accounting grew since 1940s. In 1963, the accounting principles board proposed statement of sources and uses of funds, but its preparation was not obligatory and was presented as complementary information in annual reports. In terms of independent auditing, it was not paid special attention by independent auditors in an obligatory way. In 1971, it was stated as change in financial condition in statement no. 19 of accounting principles board and was obligatorily identified as an integral component instead of financial statement and uses of funds. The existence of this statement meant cash and working capital.