Predictive Ability of Earnings from Business-Type Activities: Evidence from State Governments

SYNOPSIS I examine whether accrual-based earnings from business-type activities in U.S. state governments help predict future operating cash flows. Although these activities are financially significant, their usefulness in assessing cash flow prospects is not well understood. Using data from state government financial statements, I find that accrual-based earnings, particularly operating income, predict future operating cash flows as effectively as current cash flow measures. Their predictive ability weakens over longer horizons and varies across states. Results indicate that operating cash flows and accrual-based earnings provide comparable information about future cash flows, whereas broader measures that include nonoperating or transfer-related items, such as change in net position, are less informative. Macroeconomic factors, including the COVID-19 period, significantly affect these relationships. These findings offer insights for state financial officers, auditors, and regulators evaluating the usefulness of GAAP-based performance measures in assessing governments’ future cash-generating capacity. Data Availability: All data used in this study are publicly available. JEL Classifications: H71; H72; H83; M48.