Prediction of Business Failure: A Funds Flow Approach

The purpose of this paper is to assess the usefulness of financial ratios derived from working capital‐based funds flow information to predict the failure of US industrial firms. Unlike cash‐based funds flow ratios, used in the previous papers, capital‐based funds ratios are less volatile, therefore they are expected to be better predictors of business failure. Moreover, the paper utilizes a more general definition of business failure than the legal definition. The analysis is carried out using a stepwise logit procedure. The results indicate that working capital‐based funds flow measures are superior to cash‐based funds flow measures in business failure prediction models.