Direct Method Operating Cash Flow Disclosures: Determinants and Incremental Usefulness

This study explores the determinants and incremental usefulness of disclosing components of operating cash flow (CFO) using the direct method in a voluntary US setting and in the Australian setting where it was mandatory prior to 2007. Based on the US voluntary sample, we find that relatively highly levered firms issuing new debt are more likely to voluntarily adopt the direct method. The results are consistent with prior literature in that direct method components are important in the debt financing process. More generally, our results suggest that direct method components of CFO are incrementally useful beyond their estimated counterparts in predicting one‐year ahead cash flows and earnings when firms are in a more volatile life cycle stage (e.g., in the growth and decline stage). Additionally, we find that the incremental usefulness is also more pronounced when there are more uncertainties in estimating the direct components; specifically, when the estimation differences are large, when firms issue new debt, and when firms have longer operating cycles. To provide further corroborating evidence, we show that the disclosed direct method components are incrementally useful beyond the estimated counterparts for the group of Australian firms with similar characteristics to the voluntary sample from the United States.