Cash Flows Indicators in the Prediction of Financial Distress




financial distress, prediction models, hybrid model, SMEs, logistic regression


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.

Author Biographies

Michal Karas, Brno University of Technology, Czech Republic

Michal Karas, Ph.D. is full time assistant professor at Brno University of Technology Faculty of Business and Management. His research interest lies in the area of financial management, especially in possibilities of predicting corporate bankruptcy and bankruptcy prediction modelling. He has articles in various journals such as Journal of Economics, Engineering Economics, E+M Economics and Management and others.

Mária Režňáková, Brno University of Technology, Czech Republic

Prof. Mária Režňáková, Ph.D. is full time professor of corporate finance at Brno University of Technology Faculty of Business and Management, head of Department of Finance. Her research interests lie in areas of financial management, financial modelling and business valuation. She has published her research results in many books, articles in various journals as Agriculture Economics, Journal of Economics, International Journal of Technology Intelligence and Planning and others.

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