Explaining Accruals Using Working Capital Efficiency

We explore the empirical strength of the relation between working capital accruals and working capital utilization efficiency. Using the approach in financial statement analysis textbooks, we model accruals (i.e., investment in working capital) as a function of sales and working capital efficiency (WCE) in the previous and the current periods. We build a model to predict current-period WCE based on firm fundamentals. Our results reveal that these factors correlate with a firm's WCE. We find that incorporating WCE variables and their interactions with sales significantly improves the explanatory power of the accrual model. We also find that the model incorporating these variables does better than other models in predicting future operating income.