Welcome to Open Science
Contact Us
Home Books Journals Submission Open Science Join Us News
Coverage of EBITDA by Operating Cash Flows as a Warning Signal About Forthcoming Bankruptcy Filing
Current Issue
Volume 4, 2017
Issue 2 (September)
Pages: 27-31   |   Vol. 4, No. 2, September 2017   |   Follow on         
Paper in PDF Downloads: 33   Since Aug. 14, 2017 Views: 1143   Since Aug. 14, 2017
Authors
[1]
Jacek Welc, Department of Regional Economics, Wroclaw University of Economics, Wroclaw, Poland.
Abstract
One of the elements of company’s fundamental analysis is an investigation of the level, structure and trends of cash flows. Negative operating cash flows or cash flows lagging behind earnings are considered a warning signal, suggesting heightened risk of future financial liquidity problems. In contrast, excesses of operating cash flows over reported profits are deemed to confirm the high cash-generating capacity of an investigated firm. In this study the operating cash flows of 87 Polish public companies, in which case a bankruptcy filing was announced in a period between the beginning of 2009 and the end of 2016, are compared to the cash flows of randomly selected non-bankrupt firms. Our research found that failed firms tend to report much higher total operating cash flows than EBITDA just before bankruptcy (in contrast to healthy companies). In contrast, in the next-to-last periods before bankruptcy, failed firms tend to report sub-par operating cash flows. Accordingly, observed excesses of operating cash flows over accounting profits, if not investigated with more scrutiny, may generate a false signal about the ostensibly high cash-generating capacity of a given firm. This is so because the artificial “improvement” of the coverage of profits by cash flows, just before the loss of financial liquidity, tends to be driven mostly by ballooning of unpaid operating payables. Consequently, it is unsustainable (if not accompanied by real improvement of operating efficiencies) and followed by the financial collapse.
Keywords
Bankruptcy Prediction, EBITDA, Operating Cash Flows, Fundamental Analysis, Credit Risk Analysis
Reference
[1]
P. Atrill, P., Financial Management for Decision Makers. Harlow: Pearson Education Limited, 2009.
[2]
H. K., Baker and G. E., Powell, Understanding Financial Management. A Practical Guide. Malden: Blackwell Publishing, 2005.
[3]
S. Bhandari and R. Iyer, R., “Predicting Business Failure Using Cash Flow Statement Based Measures”, Managerial Finance, vol. 39, pp. 667-676, 2013.
[4]
E. F., Brigham and J. F., Houston, Fundamentals of Financial Management. Mason: Thomson South-Western, 2007.
[5]
C. Casey and N., Bartczak, “Using Operating Cash Flow Data to Predict Financial Distress: Some Extensions”, Journal of Accounting Research, vol. 23, pp. 384-401, 1985.
[6]
F. J., Fabozzi and P. P., Peterson, Financial Management and Analysis. Hoboken: John Wiley & Sons, 2003.
[7]
M., Fridson and F., Alvarez, Financial Statement Analysis. A Practitioner’s Guide. New York: John Wiley & Sons, 2002.
[8]
J. A., Gentry, P., Newbold, and D. T., Whitford, “Predicting Bankruptcy: If Cash Flow’s Not the Bottom Line, What Is?”, Financial Analyst Journal, vol. 41, pp. 47-58, 1985.
[9]
J. Gupta, N., Wilson, A., Gregoriou and J., Healy, “The Value of Operating Cash Flow in Modeling Credit Risk for SMEs”, Applied Financial Economics, vol. 24, pp. 649-660, 2014.
[10]
A. H., Khan and M. R., Guruli, “Predicting Bankruptcy by Liquidity Ratios Analysis”, Journal UMP Social Sciences and Technology Management, vol. 3, pp. 372-380, 2015.
[11]
C. W., Mulford and E. E., Comiskey, Creative Cash Flow Reporting. Uncovering Sustainable Financial Performance. Hoboken: John Wiley & Sons, 2005.
[12]
J. A., Ohlson, “Financial Ratios and the Probabilistic Prediction of Bankruptcy”, Journal of Accounting Research, vol. 18, pp. 109-131, 1980.
[13]
J. Pettit, Strategic Corporate Finance. Applications in Valuation and Capital Structure. Hoboken: John Wiley & Sons, 2007.
[14]
T. R., Robinson, H. Van Greuning, E., Henry and M. A., Broihahn, International Financial Statement Analysis. Hoboken: John Wiley & Sons, 2009.
[15]
K. R., Subramanyam and J. J., Wild, Financial Statement Analysis. New York: McGraw-Hill / Irwin, 2009.
[16]
A., Unegbu and J., Adefila, “Efficacy Assessments of Z-Score and Operating Cash Flow Insolvency Predictive Models”, Open Journal of Accounting, vol. 2, pp. 53-78, 2013.
[17]
J. C., Van Horne and J. M., Wachowicz, Fundamentals of Financial Management. Harlow: Pearson Education Limited, 2008.
[18]
P., Verninmen, P. Quiry, M. Dallocchio, Y., Le Fur and A., Salvi, Corporate Finance Theory and Practice. Chichester: John Wiley & Sons, 2005.
[19]
T. J., Ward and B. P., Foster, “A Note on Selecting a Response Measure for Financial Distress”, Journal of Business, Finance and Accounting, vol. 24, pp. 869-879, 1987.
[20]
W. Zhang, “Real Activities Manipulation to Meet Analysts’ Cash Flow Forecasts”, SSRN Electron. J.: https://ssrn.com/abstract=1013228, 2008.
Open Science Scholarly Journals
Open Science is a peer-reviewed platform, the journals of which cover a wide range of academic disciplines and serve the world's research and scholarly communities. Upon acceptance, Open Science Journals will be immediately and permanently free for everyone to read and download.
CONTACT US
Office Address:
228 Park Ave., S#45956, New York, NY 10003
Phone: +(001)(347)535 0661
E-mail:
LET'S GET IN TOUCH
Name
E-mail
Subject
Message
SEND MASSAGE
Copyright © 2013-, Open Science Publishers - All Rights Reserved