Cash Flows Indicators in the Prediction of Financial Distress

Abstract

We argue that the conventional approach to bankruptcy modelling, which relies on accrual-based ratios, is vulnerable to the earnings management of a company threatened by insolvency. This fact may pose significant limits on the possibilities of distress prediction. Business distress is defined as cashflow insufficiency, and cashflow indicators are less vulnerable to earnings management. For these reasons we assume that cashflow ratios are theoretically more suitable for predicting distress. In our research we analysed the usefulness of cashflow-based ratios as potential predictors of bankruptcy. During the research, the cashflow-based ratios take the form of many variants of operating, financial, investment and free cashflow into a firm in combination with total assets, sales, liabilities and other indicators. The research was carried out on a sample of 4,350 Czech manufacturing SMEs operating during the period between 2013 and 2018. We employ the previously published approach of hybrid modelling to create the prediction model, though we propose a modification for the purposes of this paper. The modified hybrid model employs Classification and Regression Trees and Logistic Regression, while we use the Principal Component Analysis method to deal with the problem of multicollinearity. The results showed that operating cashflow ratios play a significant role in financial distress, especially when combined with short-term debts.

Effect of Corporate Governance Mechanism and Operating Cash Flow on Financial Distress

“…The greater the value of operating cash flow, the smaller the possibility of the company experiencing financial distress and conversely the smaller the value of operating cash flow, the greater the possibility of the company experiencing financial distress. The results of this study support the research of Fawzi et al (2015), Kordestani & Bakhtiari (2011), Safiq & Kusumastati (2020), Kamaluddin, A, et.al (2019 and the research of Karas & Reznakova (2020).…”

“…The results study of Safiq et al (2020) show that future cash flows can provide a signal about financial distress. Karas & Reznakova (2020) examines the ability of cash flow to predict financial distress because insufficient cash flow has a close relationship with business difficulties. In addition, the cash flow approach has also been widely recognized in estimating business value and meeting the going concern assumption of the company, namely financial viability.…”

The Effect of Financial Performance on Investor Reaction With the Timeliness of Financial Statement Submission as a Mediation Factor

“…Fawzi et al (2015) [20] stated that the cash flow ratio is a variable that can predict financial pressure. This opinion is supported by Safiq et al (2020) [21] and Karas & Reznakova (2020) [22] regarding the ability of cash flows to predict financial stress. Rabia & Sibel (2012) [23] stated that cash flow is a significant variable to predict future cash flow.…”

Untitled

“…Gambar 1. Pertumbuhan Sektor Transportasi Sumber: Publikasi BPS tahun 2021 Q4 Peristiwa ini banyak memicu perusahaan jasa transportasi mengalami Financial distress dikarenakan ketidakmampuan perusahaan membayar kewajiban (Karas dan Reznakova, 2020). Kondisi seperti ini kemudian menjadi pertimbangan investor yang ingin melakukan investasi.…”