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Accounting Research Center, Booth School of Business, University of Chicago

Using Operating Cash Flow Data to Predict Financial Distress: Some Extensions
Author(s): Cornelius Casey and Norman Bartczak
Source: Journal of Accounting Research, Vol. 23, No. 1 (Spring, 1985), pp. 384-401
Published by: Wiley on behalf of Accounting Research Center, Booth School of Business,
University of Chicago
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Journal of Accounting Research
Vol. 23 No. 1 Spring 1985
Printed in U.S.A.

Using Operating Cash Flow Data to


Predict Financial Distress: Some
Extensions
CORNELIUS CASEY* AND NORMAN BARTCZAKt

1. Introduction
Recently, financial statement users and regulatorsof publicly reported
financialaccountingdata have arguedin favorof the disclosureof detailed
informationon firms' current operating cash flows (Harris et al. [1980],
FASB [1981], Smith [1982], and Thomas [1982]). The FASB suggests
that such disclosureswill allow users to assess better the amount, timing,
and uncertainty of future cash flows. It states that "the greater the
amount of future net cash inflows from operations,the greaterthe ability
of the enterprise to withstand adverse changes in operating conditions"
[1981,p. 11]. The presumptionthat historicaloperatingcash flows enable
better assessments of future cash flows, however, is based on intuition
rather than on empiricalevidence (Griffin [1982]).
Our study was conducted to assess whether operating cash flow data
and related measures lead to more accuratepredictions of bankruptand

* Associate Professor, Dartmouth College-the Editors of the Journal of Accounting


Research were saddened to learn of the death of Professor Casey in October 1984; t Lecturer,
Harvard University. The authors gratefully acknowledge the helpful comments of partici-
pants in accounting workshops at several universities. Suggestions made by E. Altman, P.
Griffin, J. Horrigan, W. Mikkelson, T. Selling, J. Shank, C. Stickney, and P. Williamson
are appreciated, as is the computing assistance rendered by D. Bower, S. Hare, D. Roberts,
and G. Peterson. J. Ohlson kindly provided many of the financial statements for the
bankrupt firms. Funding for this project was provided by the Tuck Associates, Dartmouth
College, and the Division of Research, Harvard Business School. [Accepted for publication
September 1984.]
384
Copyright C), Institute of Professional Accounting 1985

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USING OPERATING CASH FLOW DATA 385

nonbankrupt firms.' Recent studies (Gombola and Ketz [1983] and


Gombola et al. [1983]) found that ratios based on operating cash flow
load on a separate statistical factor, suggesting that operating cash flow
variables may be useful in descriptive and predictive studies involving
financial ratios. Our results suggest otherwise, at least with respect to
bankruptcy prediction.
In another study (Casey and Bartczak [1984]) we reported that accrual-
based multivariate discriminant models forecasted corporate bankruptcy
more accurately than any single operating cash flow ratio. The focus of
the present study is on the marginal predictive content of the operating
cash flow ratios, in contrast to our previous study which examined their
univariate predictive value. The poor performance of the operating cash
flow ratios in the previous study does not preclude their ability to enhance
predictive power when used in combination with accrual-based ratios.
Previous accounting studies have been unable to document the existence
of incremental information content in operating cash flow data (Bowen,
Burgstahler, and Daley [1984]). Unlike the present study, these studies
have used restrictive surrogates for measuring cash flow from operations,
and thus the issue of whether operating cash flow data have incremental
information value is unresolved.
In section 2 we review prior bankruptcy studies that have examined
the potential usefulness of operating cash flow data. Section 3 describes
the methodology employed in the present study, including selection of
sample firms and analyses applied to the firms' accounting data. Results
are presented in section 4, followed by some limitations of the study and
possible directions for future related research in section 5.

2. Previous Research
Most accounting and finance studies of corporate financial distress
define "cash flow" as net income plus nonworking capital expenses, so
they omit items such as changes in current assets and current liabilities
which may have a significant impact on a company's actual cash flow
from operations. This has led to suggestions for broader measures of cash
flows (e.g., Largay and Stickney [1980] and Gombola and Ketz [1983]).
Our definition of cash flow from operations (CFO) is essentially the same

' Bankruptcy was selected as the specific form of financial distress and as the criterion
event for three primary reasons: (1) the direct and indirect costs of bankruptcy are
significant in relation to the value of the firm (Altman [1983a]): (2) results from this study
can be compared with previous studies of bankruptcy prediction; (3) the costs of data
gathering and the problem of interpreting the economic significance of other events (e.g.,
loan default) were viewed as greater than the benefits of using events whose occurrences
are arguably less subject to noneconomic factors than is bankruptcy. Thus, while bankruptcy
prediction per se is not the main focus of this study, bankruptcy is nonetheless a convenient
event for assessing one aspect of the information value of operating cash flow data.

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386 JOURNAL OF ACCOUNTING RESEARCH, SPRING 1985
as theirs: working capital provided by operations, plus or minus changes
in the noncash working capital accounts except for short-term indebt-
edness (seasonal bank loans, nontrade notes payable, and the current
portion of long-term debt). This concept of operating cash flow is also
consistent with the recent FASB Exposure Draft [1981].
Empirical research on the relationship between CFO and financial
distress has provided only limited evidence that such data are useful in
discriminating between troubled and healthy firms (table 1). None of the
studies listed there was validated using separate holdout samples of
bankrupt companies. Moreover, the proportion of failed firms in all of
the studies except that of Largay and Stickney [19801, which involved
only one company, was close to or equal to 50%. This is likely to lead to
artificially low overall error rates (Deakin [1977]).2
Some basic differences between our study and those of previous studies
are: (1) a focus on the potential marginal improvement in classification
accuracy using CFO; (2) a larger number of sample firms and a smaller
proportion of failed firms; (3) a validation of the results based on a
holdout sample; (4) a preliminary canonical correlation analysis of the
amount of variance in the operating cash flow ratios already accounted
for by accrual-based ratios; and (5) the inclusion of first-order interac-
tions between the operating cash flow and accrual-based ratios.
The expectation of the FASB (and others) that the level of operating
cash flow will serve as a useful indicator of the likelihood of financial
distress does not derive from any formal theory. It is merely consistent
with an apparent shift in preference by many analysts to use cash flow
data for assessing a firm's financial performance (Hawkins [1977]). The
present study neither proposes nor tests any theory of the probability of
financial distress. While such theories do exist (see Scott [1981] for a
survey; also Emery and Cogger [1982]), no one theory is generally
accepted (Ball and Foster [1982]) and none gives specific attention to
our measure of operating cash flow.

3. Method
3.1 SAMPLE FIRMS
The sample firms are the same companies used in our previous study
on operating cash flows (Casey and Bartczak [1984]). Sixty firms were
selected that had petitioned for bankruptcy during the period 1971-82.
The bankrupt firms were a subset of the 105 failed firms used in a
previous study (Ohlson [1980]) and included firms listed by Dun and
Bradstreet and the Wall Street Journal Index. Criteria for inclusion in

2
Type II error is the classification of a nonfailed firm as failed; Type I error is the
classification of a failed firm as nonfailed; overall error rate is a weighted combination of
Type I and Type II error rates.

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USING OPERATING CASH FLOW DATA 387

the present study were: (1) the stock of the company was publicly traded,
and (2) at least five, and in some cases six, years of published financial
statements were available prior to the failure date. The first criterion
was imposed in order to undertake a related study involving market value
data. The second allowed for the inclusion of a trend variable in the
analyses. We also made sure that the data for the first year prior to
failure were actually publicly available prior to the bankruptcy petition
date (Ohlson [1980]) by requiring all audit opinions for the first year
data to be dated prior to the bankruptcy petition date. The average time
between the date of the financial statements for the first year prior to
bankruptcy and the bankruptcy filing date was 11.6 months. This com-
pares to 7.5 months in Altman's [19681 study and 13 months in Ohlson's
[1980] study. Of course, a survival bias was unavoidably injected into the
analysis as a result of the second criterion. In addition, complete financial
statements for some firms were not available in our libraries, which
further reduced the sample to 60 companies. The failed firms spanned a
wide range of sizes and industry classifications.
A sample of 230 nonfailed firms was chosen from the Compustat
Industrial Tape. The nonfailed firms were selected to match the industrial
classifications of the failed firms, to the extent possible. Industry classi-
fication was controlled for explicitly rather than included as an inde-
pendent variable for three reasons. First, the discriminatory power of
industry membership was not an issue in the present study; rather, the
focus was on the marginal information value of operating cash flow data
relative to only other financial data. Second, many different industries
were represented in the study which would have required numerous
categorical independent variables, one for each industry. This would have
seriously reduced our degrees of freedom in estimating the parameters of
the statistical estimation models. Third, analysts are less inclined to
make comparisons of ratio values across industries since they are gen-
erally aware that the distributions of ratios are frequently industry
specific. Consequently, there is little loss of generalizability due to
controlling explicitly for industry membership.
The firms were not matched on size, nor was size included as an
independent variable, even though it has been found to be a significant
discriminator in previous bankruptcy prediction research. Matching on
size would have limited the generalizability of the study's findings to
firms of equal size. More important, the discriminatory power of size was
not an issue of particular interest in the present study. Finally, any
potential dispersion resulting from not controlling foXsize was mitigated
by the scaling effect inherent in the financial ratios used as independent
variables.
The financial data for the nonfailed firms were taken from time periods
contemporaneous with the failed firms. The sample size of 230 resulted
from applying two selection criteria in addition to those used in selecting

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388 C. CASEY AND N. BARTCZAK

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USING OPERATING CASH FLOW DATA 389

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390 C. CASEY AND N. BARTCZAK

the bankrupt firms. First, firms with missing values on the Compustat
tape were eliminated. Second, to control for a possible industry bias,
nonfailed firms were randomly eliminated from those industries with
disproportionatelylarge numbers of firms relative to other industries in
the sample. The resulting ratio of approximatelyfour nonbankruptfirms
to one bankrupt firm was also the median ratio of nonfailed firms to
failed firms over all industries.
To avoid including nonfailed firms that might be viewed as near
bankrupt, which could lessen the potential incremental discriminating
powerof the operatingcash flow variables,we searchedPredicasts'F and
S Index of CorporateChangefor the years 1971-82. Based on its review
of multiple sources, this publication highlights significant company
events, including unfavorablefinancial occurrences (e.g., omission of a
preferreddividend).We established that none of the nonfailed firms was
listed by Predicasts for any such reasons.
3.2 INDEPENDENT VARIABLES
The operating cash flow variables examined in this study were CFO,
as previously defined, CFO divided by current liabilities, or CFCL,and
CFOdividedby total liabilities, or CFTL.Multivariatemodels (described
below) that did not include operatingcash flow ratios were employed as
convenient standardsfor assessing the marginaldiscriminatorypower of
the operating cash flow variables. These models are identical to the
accrual-basedmodels employedin our previousstudy in which the related
classification accuracyproved significantly greater than accuracybased
on the univariateoperatingcash flow ratios (Casey and Bartczak [1984]).
CFO was selected for analysis because its supposed predictive value
has been highlighted recently in the accounting literature and financial
press more than any other measure of cash flow. CFCLand CFTL were
included since CFOby itself abstracts from indebtedness,a factor which
a priori is likely to be related to the occurrenceof bankruptcy.Separate
measures for current and total indebtedness were included, since it was
not evident which measure was more likely to be related to bankruptcy,
although technical insolvency (i.e., the inability to meet current obliga-
tions) has been cited as a frequentcause of formalbankruptcydeclaration
(Altman [1983b]). The multivariatemodels used as standards consisted
of six ratios (hereafter, accrual-basedratios): cash/total assets, current
assets/total assets, currentassets/current liabilities, sales/current assets,
net income/total assets, and total liabilities/owners' equity. These ratios
have generated high loadings on orthogonal dimensions in previous
studies (Chen and Shimerda [1981]). Each of the first five ratios also
loaded highest on a statistical factor in a prior bankruptcystudy (Libby
[1975]).
3.3 ANALYSES
All analyses describedin this and later sections were conducted both
with and without outliers, where an outlier was defined as a companyfor

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USING OPERATING CASH FLOW DATA 391
which any ratio in any year was more than four standard deviations from
its group mean. Because the vast majority of results were not affected
significantly by inclusion or exclusion of outliers, results are presented
for all 290 firms.
Canonical correlation analyses were first performed for each year on
the two sets of six accrual-based and three operating cash flow ratios in
order to ascertain their canonical roots and indices of redundancy. If the
two sets of ratios were highly positively correlated, the value of an
analysis of the marginal discriminatory power of the operating cash flow
variables would be a moot point.3
Both linear multiple discriminant analysis (MDA) and conditional
stepwise logit analyses were conducted for each year. We decided to
employ linear as opposed to quadratic MDA, even though the variance/
covariance matrices of financial ratios of the bankrupt and nonbankrupt
firms were unequal (Box's F-test, a < .01 for all analyses). We did so
because previous research (Lachenbruch [1975]) has shown linear MDA
to be robust to violations of this assumption, especially when large sample
sizes are used (see also Altman, Haldeman, and Narayanan [1977] who
found that linear MDA significantly outperformed quadratic MDA).
Logit analysis was employed because of its frequently cited conceptual
advantages relative to multiple discriminant analysis (e.g., Zavgren
[1983]).

4. Results
4.1 MULTIPLE DISCRIMINANT ANALYSES (MDAs)
Eight MDAs were run using the Cooley and Lohnes [1971] program.
Classifications were performed using a chi-square procedure, as well as
one based on a Euclidean distance measure. The classification results
were essentially insensitive to the choice of the classification procedure,
so only the chi-square classifications are reported. The eight MDA models
were run using the six accrual-based ratios alone and using the six ratios
plus one or more of the operating cash flow ratios. For the first year prior
to failure, the average annual first differences in the cash flow ratios for
the preceding four years were also included.
Each of the MDAs was constructed with standardized, log-transformed
ratios, using a proportionately stratified random sample of 50% of the
total sample of 290 firms. Classification results were based on the 50%
holdout sample. All discriminant analyses assumed equal prior probabil-
ities of group membership. These assumptions are consistent with most
previous studies. Moreover, using real-world-based prior probabilities of

'The first canonical roots were statistically significant (Bartlett's approximate chi-
square, a < .01) in all five years. A redundancy index, the equivalent of R2 in multiple
regression, was also computed for each year and indicated that the accrual-based ratios
could explain no more than 30% of the variance in the set of operating cash flow ratios.
This finding justified a further investigation of the potential marginal information value of
the cash flow ratios.

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392 C. CASEY AND N. BARTCZAK

bankruptcy and asymmetric loss functions has a canceling effect that


has not led to improved results in previous bankruptcy studies (Altman
[1983b]).
Because of statistically significant levels of multicollinearity in each
year, no attempt was made to assess the relative contributions of the
individual independent variables to their respective multivariate models.
Multicollinearity aside, the value of such assessments is questionable at
best and misleading at worst. A survey of previous bankruptcy studies
(Altman [1983b]) indicates that the relative contribution of individual
financial ratios is very sample specific.
All MDA models were statistically significant (a < .05) for the first
three years prior to bankruptcy. The univariate F-ratios for the operating
cash flow variables did not exhibit a consistent pattern. CFCL was
statistically significant (a < .05) for the first three years, CFTL for the
first two years, and CFO for the first, fourth, and fifth years prior to
bankruptcy. The group means for CFO, CFCL, and CFTL are displayed
in figure 1. None of the differences between group means of the average
annual first differences in the operating cash flow variables was statis-
tically significant.
The main issue here is whether a marginal increase in classification
accuracy can be achieved by including operating cash flow ratios. Clas-
sification results by year for the MDA model based on the six accrual-
based ratios alone and for the best performing MDA model that contained
one or more cash flow ratios are presented in table 2.4 Two observations
can be made. First, classification accuracy was not improved by the
addition of the operating cash flow variables, either in a practical or a
statistically significant sense for the bankrupt, nonbankrupt, or total
groups of firms. The reason was the high level of within-group dispersion
on the operating cash flow ratios. Figure 2, which is representative of all
five years, makes this clear. The exception was the fourth year prior to
failure for the bankrupt group of firms, but this result was one of the few
cases sensitive to the inclusion of outliers. When the outliers (17 non-
bankrupt, 9 bankrupt firms) were removed, no significant differences in
classification accuracy between models remained. Second, the results in
terms of the level and trend of accuracy across years are generally
consistent with the findings of previous bankruptcy studies. The rela-
tively lower accuracy rates in the first year were probably caused by the
use of "older" data for the first year for those firms whose most recently
issued financial statements were unavailable prior to the date of the
bankruptcy petition filing.
4.2 LOGIT ANALYSES

Several stepwise logistic regressions were run for each year based on
the same ratios and a stratified random sampling procedure used in the

4Details of the results based on the other models are available upon request from the
authors.

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USING OPERATING CASH FLOW DATA 393
56.1

N (in $ millions)
CF

,~.;/Y~f7' 4.5 4.6

-3.9 - 0

CFCL

.28 . 5
.32

- .09
- - - -
---
.03 - 12 --

CFTL

.17 .15 .21 .19

. .02 -.01 t05. __-- 75 _

1 2 3 4 5
Year Prior to Failure

FIG. I.-Means of healthy (nonbankrupt)and failed (bankrupt)firms.

MDA models. First-order interaction effects between the respective op-


erating cash flow variable and the six accrual-based ratios were also
allowed to enter the models. The results did not vary significantly across
the logit models that incorporated one or more of the operating cash flow
variables, so only the results for the marginally best-performing operating
cash flow model and the accrual-based ratio model are shown here.
The "best-performing" operating cash flow model allowed entry of the
six accrual-based ratios, the three operating cash flow ratios, and the
interactions between CFO and CFCL and between CFO and CFTL, based
on a-levels for entry and removal of variables of .10 and .20, respectively.

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394 C. CASEY AND N. BARTCZAK

TABLE 2
Resultsfor MDA Models

YearPrior . Criticala-Level ClassificationAccuracy


to Bankruptcy (Rao'sF-Test) Bankrupt Nonbankrupt

Six Accrual-Based 1 10.34 <.01 87 83 86


Ratios Alone 2 12.40 <.01 89 63 84
3 4.31 <.01 90 57 84
4 2.19 <.05 83 30 72
5 1.34 <.25 58 73 61
Six Accrual-Based 1 8.87 <.01 87 87 87
Ratios and CFTL 2 10.97 <.01 87 67 83
3 3.76 <.01 90 60 83
4 1.98 <.06 76 47 70
5 1.15 <.34 57 70 60

Entry or removal of a variable was determined by the maximum like-


lihood ratio method. A summary of the stepwise results for each year is
presented in table 3. Table 4 contains two sets of classification results,
the first based on a cutoff probability of failure equal to .50, the second
based on the cutoff probability that minimizes the number of misclassi-
fication errors.
Table 3 indicates that in four out of five years, an operating cash flow
variable provided a statistically significant increment to explanatory
power. Nevertheless, table 4 shows that these increments could not be
exploited either practically or statistically to achieve improvement in
classificationaccuracyfor the nonbankrupt,bankrupt,or total groups of
firms. This result held for both cutoff probabilities indicated in table 4,
and for others ranging from .008 to .992. Thus these findings are not
sensitive to asymmetries in users' loss functions. The main reason behind
this result is evident from the strong similarity for the accrual-based and
the operating cash flow models' histograms and plots of the percentages
of correct classifications for year 1 (figures 3-4 and 5-6, respectively).
Years 2 and through 5 exhibited similar overlaps.
Our results are consistent with the findings of other studies (e.g.,
Kaplan and Urwitz [1979], Ohlson [1980], and Gentry, Newbold, and
Whitford [1985]), which have found that MDA and either logistic or
probit regression generate similar results, notwithstanding the assumed
advantages of the latter. The findings support Ohlson's conclusions that
"many 'reasonable' [statistical estimation] procedures will lead to results
which will not differ too much" [1980, p. 129].

5. Summary and Directions for Future Research


This study provides evidence on whether operating cash flow data can
increase the accuracy of accrual-based multiple discriminant and logit
models to distinguish between bankrupt and nonbankrupt firms. Our

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USING OPERATING CASH FLOW DATA 395

Minimum= -137.693
Maximum = 1542.84
i 1Mean
Et O = 43.7155
Std Dev = 159.29

Non-Bankrupt

4;ankruPt

Minimum= -2.14186
1
^A Maximum = 3.77107
cfcli Mean = .355251
Std Dev = .502393

Non-Bankrupt

.Ban k/S .
Minimum= -.512727
s 1 _J Maximew= 3.77107
cf T.1 A Mean = .207089
on-Bankrupt Std Dev = .373186

\Ba u

FIG. 2.-Distributions of operating cash flow variables one year prior to bankruptcy.

results suggest that operating cash flow data do not provide incremental
predictive power over accrual-based ratios. Hence, the results fail to
support the conclusion by some (e.g., Gombola et al. [1983]) that the
omission of cash flow ratios in bankruptcy studies by Altman [1968] and
others may have been inappropriate. These finding are consistent with
those of our previous study (Casey and Bartczak [1984]) and are also

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396 C. CASEY AND N. BARTCZAK

TABLE 3
Summaries of Stepwise Logit Analyses

Step Log Stepwise Critical


Year Number Ratio Entered Likelihood Improvement a-Level
Chi-Square
1 0 -73.924
1 CurrentAssets/Current -60.368 27.110 0.000
Liabilities
2 CFO x CFCL -48.629 23.479 0.000
3 Current Assets/Total -42.199 12.859 0.000
Assets
4 Net Income/Total As- -37.366 9.666 0.002
sets
2 0 -73.924
1 Net Income/Total As- -62.581 22.686 0.000
sets
2 CFCL -58.113 8.935 0.003
3 Current Assets/Current -53.514 9.199 0.002
Liabilities
4 Current Assets/Total -51.211 4.605 0.032
Assets
5 Cash/Total Assets -48.951 4.520 0.034
3 0 -73.924
1 Net Income/Total As- -64.440 18.966 0.000
sets
2 Cash/Total Assets -60.821 7.239 0.007
3 Current Assets/Current -58.575 4.492 0.034
Liabilities
4 Current Assets/Total -54.691 7.768 0.005
Assets
4 0 -73.924
1 Cash/Total Assets -67.235 13.377 0.000
2 CFO -62.334 9.803 0.002
3 Current Assets/Current -60.597 3.474 0.062
Liabilities
5 0 -73.924
1 CFCL -67.432 12.984 0.000
2 Cash/Total Assets -62.189 10.486 0.001

generally consistent with the results of the Gentry, Newbold, and Whit-
ford [1985] and Gombola et al. [1983] studies, neither of which found
CFO to improve classification accuracy significantly.
Notwithstanding our findings, other possible uses of operating and
nonoperating cash flow data should be explored. For example, operating
cash flows may provide improved predictions of other events of interest-
for example, corporate acquisitions, loan defaults, and dividend omis-
sions. Similarly, a broader definition of cash flows, for example, total
cash flows, might lead to improved classification accuracy.
No attempt was made in this study to explore the predictive ability of
operating cash flow data when used in conjunction with nonfinancial

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USING OPERATING CASH FLOW DATA 397
TABLE 4
Classification Accuracy of Stepwise Logit Models (%)
INDEPENDENTVARIABLESET*

Six Accrual-BasedRatios Nine Ratios Including


CEO CFCL CFTL
FirmCategory NB B T NB B T
Year Prior to
Bankruptcy
1 95 63 88 96 53 87
95 63 88 (.50) 94 63 88 (.425)
2 95 40 84 96 40 84
93 53 85 (.425) 97 37 85 (.608)
3 95 40 84 95 40 84
98 37 86 (.542) 97 40 86 (.542)
4 98 20 82 95 40 84
97 30 84 (.46) 96 40 84 (.50)
5 97 13 80 98 13 81
100 10 81 (.575) 97 27 83 (.425)
*
The first row of accuracy rates in each year is based on a cutoff probability of failure
equal to .50. The second row of accuracy rates in each year is based on the cutoff probability
which maximizes total classification accuracy.

Histogram of Predicted Probabilities of Failure for


Group Bankrupt Using Accrual-Based Ratios
"M"Marks the Median, "Q" Marks the Quartiles

X XX X X X. X
X X)( X XXX X X )( ' X X XX X X X XXSX.X
-.- _
He+_-__ ___+_1 --- ---- 0- _ *2+M-__d -c -+- --+ ---+G W- _+_ +

o .17 .33 .50 . 67 . FI3 .C)

Histogram of Predicted Probabilities of Failure for Group Non-bankrupt


Each "X" Represents 2 Responses, "*" Represents Fewer than 2 Responses
"M" Marks the Median, "Q" Marks the Quartiles
*

X
XX
XX
XX
OX
XX
XX
XXX
XXXX
XXXX*X *
XXXXXX **X*
XXXXXXXXXXX ***XX *X*X * *X
+QM-+G+++
- - - --_ _*
__
0 . 17 . 33 .50 . 67 . 83 1. 0

FIG. 3.-Six accrual-based ratios.

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All use subject to JSTOR Terms and Conditions
Cutpoint
0. 00 .110 360 [4A0 7.20 .900 1. 08
090 ...
270 + ....
450)
F .. F f
.C)... ..
.81() 990
+ -. . ..t . ,-I... +. - %
--
100. 0 1FF S6661 2SSS6S3SSS
FFFFFF 89 33SSc33663SS6SiS
SSSS.SS

F 5
87. 50 + FFFF S63SS*S ******
**** ** * t****1>**** ********
* fi+rE *****FI
*
***
*36 **

P 7S. 00o **S


E . S
R . *F F
C ~ . 6 F=
t , *
N 62. 50 t- S FFF!-:
T . *
L F F

U . 6 I:[FF
R 50.00 + IFF
R . F
E
C . S VF
T .* F
37. 50 +

FFFFF
FF
FFFFF
25. 00 +
.6 Fl+FFF
F
F
12. 50 +
F
F

0. O06 + F

FIG. 4.-Percentage of correct classification as function of the cutpoint for accrual-based


model. Plot characters are first characters of group names and * = total. F = failure
(bankrupt) and S = success (nonbankrupt).

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USING OPERATING CASH FLOW DATA 399
Histogram of Predicted Probabilities of Failure
for Group Bankrupt Using Operating Cash Flow Ratios
"M"Marks the Median, "Q" Marks the Quartiles
X .'x X X X X
X X X X XX XX XX B: AX X XXXf XX X X XXX

o .i 7 .3Z1 .50 .67 .83 1. 0

Histogram of Predicted Probabilities of Failure


for Group Non-bankrupt
Each "X" Represents 2 Responses, "*" Represents Fewer than 2 Responses
"M"Marks the Median, "Q" Marks the Quartiles
*

X
X
X
X
X

X
X
X
X
X
X
X

XX
XX
XX
XX

XX**
XXXX X *
XXXXXX*XX X***X' X X * ?X X * X

0 . 17 . 33 .5}O.0. . 1. 0

FIG. 5.-Nine ratios.

information, or with financial data other than the six ratios included in
the multivariate empirical model. Thus, model misspecification could be
an issue. Also, the specific characteristics of the operating cash flow
variables examined in this study (i.e., their levels and interactions) by no
means exhaust their total statistical properties. For example, Emery and
Cogger [1982] posit the variance of total cash flows to be a significant
dete rminant of a firm's viability. Future research might investigate the
possible predictive ability of higher-order moments of the distributions
of operating cash flow variables.
The time period studied here spanned more than a decade, and it is
possible that the predictive ability in operating cash flow data varied
over this period. Gombola et al. [1983] found that the coefficient attached

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400 C. CASEY AND N. BARTCZAK

Cutpoint

0. 00 . 180 .360 .540 .720 .900 1. 08


.090 .270 .450 .6,530 .810 .990
+ .
+. . . . . . . 4. . . .
. . . . . .

100.0 CFFF: SS5SSSSSS


FFFFF SSSSS8SSSSSGS
ssSss
FFFFFF SSSSSSSS
FF S
87. 50 4 ********X*** ***** *
* ~ ~~~'
p.***5x $ *a*
***SSS

*8 FE
P 75.00 +i 3
E . *8 F.
R . * FFF
C . S F
E . *5
N 62.50 + S IFFFF
T
FF
C
0 . F-f:
R 50.00 +
R . FFF
E
C .S
T . F
37.50 -F F

F
FF
F
25.00 +
FF
FFFFF FEF
FE

12.50 +
F
F

0. 000 + F

FIG. 6.-Percentage of correct classification as function of the cutpoint for operating


cash flow model. Plot characters are first characters of group names and * - total. F =
failure (bankrupt) and S = success (nonbankrupt).

to an operating cash flow factor score was statistically significant for the
first year prior to failure during the period 1973 to 1977, but not prior to
1973.5 Accordingly, research which investigates the potential sensitivity
of this study's findings to variation in time periods might be useful.

'The practical significance and generalizability of this finding is unclear, since the
authors did not validate their finding on an independent holdout sample.

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