Using the combinations of cash flow components to predict financial distress

This dissertation examines whether the combinations of cash flow components segregated by activities help predict impending financial distress relative to other financial information. Firms experience financial distress if they cannot generate adequate cash to meet their needs. When financially distressed firms fall short of cash from operations, they obtain cash from investing and financing activities to mend their financial problems. Information about the relationships among operating, investing, and financing cash flows is expected to provide users with another approach for evaluating whether firms are performing well or facing financial distress. In this study, eight combinations of operating, investing, and financing cash flows are used as predictors in the financial distress prediction models. The findings support the hypothesis that the combinations of cash flows from operating, investing, and financing activities reported in the statement of cash flows during a fiscal period are predictive of financial distress incremental to other financial information. Relative to healthy firms, distressed firms are more likely to have the following cash flow combinations: (1) the combination of negative net operating cash flow, positive net investing cash flow, and negative net financing cash flow; and (2) the combination of negative net operating, investing, and financing cash flows. In contrast, compared to healthy firms, distressed firms are less likely to have the following cash flow combinations: (1) the combination of positive net operating cash flow, negative net investing cash flow, and positive net financing cash flow; and (2) the combination of positive net operating cash flow and negative net investing and financing cash flows. Empirical evidence suggests that firms face financial distress when they generate insufficient cash from operations to meet ongoing cash needs. Financially distressed firms acquire additional cash from investing activities or use their cash reserve to solve financial problems. However, their financial problems become more severe if they run out of assets that can be sold or if their cash reserve is exhausted