Incentives to Inflate Reported Cash from Operations Using Classification and Timing. Timing.

Abstract

This paper examines when firms manage reported cash from operations in the statement of cash flows (CFO) and the mechanisms through which CFO can be managed. CFO management as investigated in this paper is distinct from earnings management. Unlike the manipulation of accruals, firms cannot manage CFO with biased estimates, but must resort to classification and timing. I identify five firm characteristics associated with incentives to manage reported CFO: (i) financial distress, (ii) a long-term credit rating near the investment/non-investment grade cutoff, (iii) less persistent earnings, (iv) a trend of diverging earnings and CFO, and (v) the existence of analyst cash flow forecasts. Results indicate that firms manage reported CFO at times when the incentives to do so are particularly high. Specifically, CFO is managed by shifting items between the statement of cash flows categories both within and outside the boundaries of GAAP and by timing certain transactions such as delaying payments to suppliers or accelerating collections from customers.