Journal of Science and Today's World

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1 Scholar Journal Journal of Science and Today's World Journal home page http// ISSN X 214, volume 3, issue 2, pages Research Article Studying the Relationship between the Quality of the Accrual Items, the Amount of Cash and Firms Free Cash Flow in Companies listed on the Tehran Stock Exchange Saeed Gheiji * Department of Commerce & Business Management, Osmania University, Hyderabad, India A R T I C L E I N F O Article history Received 21 December 213 Accepted 26 January 214 Published 6 February 214 Keywords Accounting Quality, the Quality of the Accrual Items, the Amount of the Preserved Cash in Firms, Information Asymmetry, Free Cash Flow *correspondence should be addressed to Saeed Gheiji, Department of Commerce & Business Management, Osmania University, Hyderabad, India, s_gheiji@yahoo.com A B S T R A C T The current study aimed at reviewing the relationship between the quality of the accrual items, the amount of cash and firms free cash flow. Therefore, the information of the accepted firms in Tehran Stock Exchange has been gathered from 23 to 28. The dependent variable is the firms preserved cash by the end of the period as well as firms free cash flow. The independent variable is the quality of the accrual items. The results demonstrate that there is a significant relationship between the qualities of the accrual items, firms preserved cash and free cash flow. Copyright 214 Saeed Gheiji et al. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. 1. Introduction The amount of the preserved cash in firms and its effective factors is one of the issues which have mostly been paid attention in financial literature. These factors include firms size, the amount of cash flow, financial leverage, liquidity ratios and etc. There have not been many studies in this regard; moreover, the conducted studies have had different results in various environments. Predicting cash flow holds special prominence for internal and external organization users. The most important goal of financial reporting is presenting information in order to predict cash flows. Some of the experts as well as providers of literature review and financial report goal setters believe that by the use of accounting profit and its components, cash flow can be predicted. But why do firms preserve cash low? The most common reply to this question may be the fact that it leads to the reduction of firms financial support [1]. Based on this viewpoint, providing finance from foreign resources is costly for firms; moreover, this cost increases in case of information asymmetry between firms and foreign investors as well as agency issues. In order to decrease these costs in imperfect markets, managers want to have a sufficient amount of cash but in maintaining the cash, there are some negative perspectives. The theories of interest conflict between shareholders and managers as well as free cash flow managers are among those which consider these aspects [1]. Free cash flow is of importance since it lets firms search opportunities and increase shareholders values. On the one hand, without having cash, it is impossible to develop brand new products, do business acquisitions; pay cash interest to shareholders and reduce liabilities. On the other hand, cash should be maintained in a level that balances between the cost of keeping cash and insufficient cash. 2. The Quality of Financial Reporting and Cash Accounting profit, which is calculated, based on the accrual accounting can be regarded as a criterion of evaluating a firm s function. Profit is of prominence because it is applied by a large number of users. There exist several usages of profit such as managers rewards, liability contracts, considering firms explanatory schemes in search of using public resources, investors and creditors. However, accounting profit according to the gained cash flow cannot function well due to matching problems and criterion timing. Therefore, the revenue recognition and matching principle is used in accounting; furthermore, the accrual items as a part of the accrual accounting profit adds to profit awareness by solving the problems which were caused as a result of measuring firm s function during performing different activities [2]. The viewpoint expressed by the American Financial Accounting Standard Board (FASB) declares that the accrual items improve the ability of profit to measure firm s function. For instance, the forty fourth paragraph of statement number one regarding financial accounting definitions expresses the followings The information in case of profit and its components which are measured by accounting accrual items totally present a better index of business unit function in comparison with the information about cash receipts and payments. However, applying accrual items includes some problems. The manager normally has authorities in identifying the optional accrual items which can use them in two ways (a) signaling the internal information of firm (b) manipulating profit so as to take advantage. Concerning the first way, information asymmetry is decreased and leads to Carater contracts. In the second way, the profit as the criterion of firm s function will be less reliable [2]. In fact, the quality of the accrual items for investors can be defined as the amount of firm s profit matching with cash flow; in addition, low quality of the accrual items reduces this match and increases firm s risk [3]. Therefore, the quality of these items can be a prominent criterion in profit quality and finally financial report and then affect various factors such as risk factor of firm and the cost of firm s investment which will eventually have an impact on the process of providing cash in order to advocate financially. Thus, taking into account the role of accounting standard disclosures in the form of correct and sufficient information as a sector of information structure, they can be regarded as a crucial and effective factor in reducing information asymmetry; moreover, the quality of this information closure is an important factor in the amount of effectiveness regarding the reduction of information asymmetry which should be considered later on. Studies have also demonstrated that information asymmetry has an impact on firm s cash inventory and by increasing information 45 P a g e

2 J. Sci. Today's World, 214, volume 3, issue 2, pages asymmetry; the amount of maintained cash is increased by firms [4; 5; 6; 7; 1; 8]. Information asymmetry and representative conflicts makes cash acquisition difficult and costly for firms. In these conditions, firms may reinforce their circulating asset so as to reduce the costs related to foreign financial dependence. In this category of studies, information asymmetry is concerned with the factors such as size, development opportunities in the form of market value to writing-off value, ownership structure and so on. In this regard, the prominent issues are the following questions 1) What are the effective factors on firms amount of cash? 2) How can the existing theories explain firms manner of cash maintenance? The recent studies have considered these issues. The present study is an attempt to review the effective factors on the rest of cash and firms free current of cash in Tehran Stock Exchange. 3. Review of the Related Literature Opler et al. studied the effective factors on firms cash flow for the US public corporations in a period of twenty-three years from 1971 to In this research, different regression methods such as Fama- MacBeth cross-sectional model, cross-sectional regression and Fixedeffects were used. In time series and cross-sectional tests, they found evidences based on confirming static dealing model in case of cash. It was especially confirmed that the firms having higher development opportunities and cash flows with more risks maintain more cash from the total non-liquid asset. Also, huge and high ranking firms which had more access to capital markets tended to maintain lower levels of the proportion of cash to the total non-liquid cash. In another study carried out by Ozkan and Ozkan, they reviewed the effective factors on firms cash inventories for some British companies from 1984 to Using cross-sectional regression and cash final model, they emphasized the importance of management ownership among other firm authority features comprising board of directors. By including the variables such as management ownership, they showed that there was a significant relationship between management ownership and firm s amount of cash. Generally, development opportunities, cash flows and liquid assets, financial leverage and bank liabilities are all prominent factors in determining firm s amount of cash. This research demonstrates that cash flows and firms development opportunities have positive impact on their cash inventories. Also, there are reliable evidences which show current assets, financial leverage and bank liabilities have negative impact on cash. Garcia et al. conducted a study in 28through which they reviewed the impact of accounting quality on firm s cash inventory from 1995 to 21 by the use of a sample consisting of Spain Stock Exchange. In this research, the manipulated secondary model similar to Ozkan and Ozkan [1] was applied. The results show the firms with high quality accrual items maintain lower levels of cash compared with the firms having low quality accrual items; furthermore, as bank liability increases, cash inventory in increased as well and the firms with more cash flows maintain more cash. One year later, in 29, Garcia et al. carried out a study. They reviewed the influence of accounting quality on firms cash inventory from 1995 to 21 by the use of a sample comprising Spain Stock Exchange. In order to measure, the quality of the accrual items was applied as the index. The quality of the accrual items was used as the original model through Dechow and Dechow model [2]. The variables such as firm s size, liability maturity and development opportunities were controlled. The conclusions demonstrated that the firms with high quality accrual items maintain lower level of cash in comparison with lower quality accrual items; moreover, by increasing bank liability, cash inventory is increased as well and the firms with higher cash flows maintain more cash, whereas more leverage firms with more cash inventories maintain less level of cash [9]. 4. Research Hypotheses Various studies carried out by different researchers such as Ozkan and Ozkan [1], Garcia-Teruel and Martinez-Solano [8], as well as Garcia- Teruel et al. all state the fact that accounting quality and more totally financial reporting increases investment efficiency via decreasing information asymmetry between firm and investors on one hand, and managers and investors, on the other hand. Altogether, information asymmetry and representative conflicts increase cash providing cost. In these conditions, in order to decrease the costs of foreign finance dependence, it is natural to maintain more cash inventories in firms. The research hypotheses are as followed 4.1. The First Research Hypothesis The firms, whose accrual items have higher accounting quality, maintain less cash The Second Research Hypothesis The firms, whose accrual items have higher accounting quality, have less free cash flow. 5. Data and Methodology The statistical population of the present study includes all the accepted financial firms in Tehran Stock Exchange from 23 to 28 whose fiscal year ends on 2th of March each year. Regarding this issue, 113 firms were selected. Considering the study as well as the hypotheses, the following models were used to test the hypotheses. The first model for the first hypothesis is (Model 1) CASHit=α+βCASHit-1+β1AQDDit+β2GROWPit+β3SIZEit+β4LTDEBit +β5bankdit+β6rspreadit+β7levit+β8liqit+β9cflowit+β1zsco REit+β11DIVit+εit The second model for the second hypothesis is (Model 2) FCASHit=α+βFCASHit-1+β1AQDDit+β2GROWPit+β3SIZEit+β4LTDEBit +β5bankdit+β6rspreadit+β7levit+β8liqit+β9cflowit+β1zsco REit+β11DIVit+εit 5.1. Regarding these models AQDD it represents measurement criterion for the quality of the accrual items; LTDEB it represents timing liability settlement; BANKD it represents the proportion of bank liability to total liability; RSPREAD it represents cash maintenance costs; LIQ it represents other cash inventories; CFLOW it represents the ability of providing cash; ZSCORE it represents the probability of financial crisis in firm; DIV it represents distribution or non-distribution of share profit; FCASHit-1 represents free cash flow by the end of the period; Explanation of the Applied Variables in the Following Model As the research hypotheses depict, the dependent variables are the amount of maintained cash and firms free cash flow; furthermore, the independent variable is accounting quality. The dependent variable is defined as follows CASH1 the ratio of cash and quick transaction investment to total repossessions In order to determine the quality of the accrual items, Dechow and Dechow [2] model was applied. As such, the quality of the accrual items is clarified through considering the power of explaining investment accrual items in current circulation about past, present and future status of cash. It is calculated as followed Model 3 WCA= C + λ1cfit 1 + λ2cfit + λ3cfit εit WCA it represents the accrual items of working capital firm i in the year t and includes change in current repossessions minus change in cash which equals cash minus change in current liabilities plus change in bank short-term liabilities. CFOit-1 respectively represent firm s operational cash in CFOit و CFOit+1 t-1, t and t+1 periods. All the variables were made homogeneous by repossession mean. Based on mean, firm s total repossessions were calculated at the end of the period (t) and at the beginning of the period (t-1). In this model, the accrual item of circulating investment is calculated as follows WCAit= CAit - CLit - CASHit + STDEBTit + DIV ΔCA represents change in current repossessions; ΔCL represents change in current liabilities; ΔCASH represents change in cash and cash equivalents; STDEBT represents change in financial facilities; Δ 46 P a g e

3 J. Sci. Today's World, 214, volume 3, issue 2, pages Δ DIV represents change in the profit of paying share; the amount of demonstrates ( εit )Finally, the amount of the remained error change in the accrual items of circulating capital which does not explain operational cash flows in the past, present and future; thus, εit can be used as an inverse criterion to measure the quality of the accrual items. AQDD=Εit, as such, the more the error is, the lower the quality of the accrual items is. past cash flows. According to these results, there is a positive relationship between capital changes in the calculated current flow and current as well as past cash; in addition, there is a negative relationship between capital changes in the calculated current flow with future cash flows. Table 3. Pearson Correlation Coefficients 6. Results 6.1. Descriptive Statistics In table 1-1, the central indices such as mean as well as median and disparity indices including standard deviation, straightness and skewness are calculated for various variables. Table 1. Descriptive Statistics In most studies which used Dechew and Dechew s model, they calculated it based on cross-sectional regression. Baharat pointed out that cross-sectional estimations solve the serious problems which are caused as a result of timing series models limitations and damage samples since in this method special timing series data are applied in each firm. This regression is performed cross-sectional every year and the remain of the regression is calculated for each firm every year Reviewing the First Model by the Use of Regression Analysis In this section, first model multi-dimensional regression is considered to be analyzed 6.2. Correlation Coefficient In matrix table 1-2, correlation coefficients of dependent variables or the original research variable i.e. the quality of the accrual items can be seen. There is a significant linear relationship between the dependent variables and the quality of the accrual items at the level of 99 percent which is depicted in table 3-4. Table 2. Correlation coefficient of accrual items quality CASH it=α+βcashit-1+β1aqddit+β2growpit+β3sizeit+β4ltdebit + β5bankdit+β6rspreadit+β7levit+β8liqit+β9cflowit+β1zscoreit +β11divit+εit In this model AQDD it represents measurement criterion of the accrual items quality; LTDEB it represents liabilities settlement timing; BANKD it represents the ratio of bank liabilities to other liabilities; RSPREAD it represents cash maintenance cost; LIQ it represents all cash repossessions; CFLOW it represents the ability of cash providing; ZSCORE it presents the probability of financial crisis in firms; DIV it presents distribution or non-distribution of share profit; In the model above, it is accidental error and, 1,..., 11 are the model factors which show slope and width from origin, respectively. The zero and alternative hypotheses are as follows in this model 6.3. Reviewing the Effect of Financial Reporting Quality on Remained Cash The research hypotheses are posed to show that regarding financial reporting, the quality of firm s accrual items is in relation with firm s remained cash. In order to test these hypotheses, first the criterion of the accrual items quality was calculated based on model 1-3. In this model, for each observe i.e. every year of the firm, one index of the accrual items quality was calculated in the form of the remain of circulating capital of the accrual items regression as well as cash in the past, present and future. In the table below, we can observe the correlation coefficients between the capital changes in current flow and H H1 i i 1,2,...,11 H H1 There is no significant model. There is a significant model. The amount of probability (or significance level) of F equals.. 47 P a g e

4 J. Sci. Today's World, 214, volume 3, issue 2, pages These amounts are less than.5; therefore, zero hypothesis at the assurance level of 95% is rejected which means there is significant model at the assurance level of 95%. ZSCORE it presents the probability of financial crisis in firms; DIV it presents distribution or non-distribution of share profit; FCASHit-1 presents free cash flow by the end of the period; Table 4. Result of first model In the model above, it is accidental error and, 1,..., 11 are the model parameters which show slope and width from origin, respectively. The zero and alternative hypotheses are as follows in this model The rate of determination coefficient equals.28 i.e. 28% of dependent variable changes are expressed by the independent variables. Practically, this rate is important. This index indicates the amount of relationship between variables. Watson s statistics does not differ much with amount of 2. The amounts around 2 show non-self-correlation of the remains (the other regression hypothesis). Table 5. Summary of first H H 1... i H H i 1,2,...,11 11 There is no significant model. There is a significant model. The amount of probability (or significance level) of F equals.. These amounts are less than.5; therefore, zero hypothesis at the assurance level of 95% is rejected which means there is significant model at the assurance level of 95%. Table 8. the result of second model Table 6. Model 1 Conclusions The rate of determination coefficient equals.28 i.e. 28% of dependent variable changes are expressed by the independent variables. Practically, this rate is important. This index indicates the amount of relationship between variables. Watson statistics amount equals 2.2. Table 8. Conclusion of Model 2 As it can be seen in the table above, t amount for CASH is 9.69, the quality of the accrual items is , future development opportunity is 2.13, size variable is , timing liabilities settlement is 4.128, opportunity cost is 2.325, all cash repossessions is , the ability of providing cash is These are located in zero hypothesis rejection area i.e. these variables are significant in the model. T amount for width from the origin at assurance level of 95% is located in zero hypothesis rejection area which shows significance of a fixed amount. Other variables are insignificant in the model because the amounts of their significance is not less than.5. The rate of determination coefficient only equals.27 meaning that there is just one less percent of dependent variable change ability in comparison with the whole model. Watson amount equals To sum up, as it is shown in the table above, according to the relationship of the accrual items quality and cash remain, the first hypothesis is accepted Reviewing the Second Model by the Use of Regression Analysis The second model is as follows FCASHit=α+βFCASHit-1+β1AQDDit+β2GROWPit+β3SIZEit+β4LTDEBit +β5bankdit+β6rspreadit+β7levit+β8liqit+β9cflowit+β1zsco REit+ β11divit+εit In this model AQDD it represents measurement criterion of the accrual items quality; LTDEB it represents liabilities settlement timing; BANKD it represents the ratio of bank liabilities to other liabilities; RSPREAD it represents cash maintenance cost; LIQ it represents all cash repossessions; CFLOW it represents the ability of cash providing; 7. Summary and Conclusion The conclusions of the present study indicate that the firms with higher quality of accrual items maintain less cash in comparison with the firms having lower quality of accrual items; therefore, accounting information quality can decrease the negative impacts of information asymmetry and costs of inappropriate choice in order to have access to foreign finance. It can also be expected that firms can reduce their cash repossessions and cash flows by increasing their information quality so cash management can be performed in a better way. The research gained results represent valuable viewpoints to managers so as to pay more attention to the quality of accounting information and cash management. Also, the relationship of control variables can attract managers attention to all the influencing factors on cash maintenance and help them reach the target cash level. Investors and credit providers can also regard accounting information quality as an effective factor in decision making. It is suggested that in this study in order to have an access to more reliable results so as to generate them, it can be conducted by considering all profit features such as stability, predictability, being on time, relevance and so on. Since there are many effective factors on the level of maintenance and cultural factors can also play an important role in these issues, the impact of cultural 48 P a g e

5 J. Sci. Today's World, 214, volume 3, issue 2, pages factors on cash maintenance can be considered in further research as well. References [1] Ozkan, A., & N.Ozkan,(24) Corporate Cash Holdings An Empirical and Implication of Corporate Cash Holdings, Journal of financial Economics 52,3-46. [2] Dechow, p., (1994) the Quality of Accruals and Earnings The Value of Accrual Estimation Errors, and Accounting Accruals, Journal of Accounting and Economics 18, [3] Francis, J.,R.Lafond,. P.M.Olsson & K.schipper,(24) Costs of Equity and Earnings Attributes, Accounting,Review 79, [4] Kim, C.S.,D.Mauer, &A.E.Sherman,(1998) The Determinants of Corporate Liquidity Theory and Evidence, Journal of Financial and Quantitative Analysis 33, [5] Opler, T.,L.Pinkowitz,R.Stulz,& R.Williamson,(1999),The Determinants and Implications of Corporate Cash Holding, Journal of Financial Economics 52,3-46. [6] Dittmar, A.,J. Mahrt-Smith, &H. Servaes,(23) International Corporate Governance and Corporate Cash Holding, Journal of Financial and Quantitative Analysis 38, [7] Ferreira, M.A., A.Vilela, (24) Why Do Firms Hold Cash? Evidence from EMU countries, European Financial Management 1, [8] Garcia-Teruel,P.J.,& P.Martinez-Solano,(28) On the Determinants of SME Cash Holding ;Evidence from Spain, Journal of Business Finance and Accounting 35, [9] Garcia-Teruel, P.,.P.Martinez-Solano,J.P.Sanchez-Ballesta,(29) Accruals Quality and Corporate Cash Holding, Accounting and Finance [1] Myers, S.C., & N.S.Majluf,(1984) Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have, Journal of Financial Economics 2, P a g e