A Comparison: Accrual Versus Cash Flow Based Financial Measures’ Performance in Predicting Business Failure

Abstract

Most business failure prediction models use accrual-accounting-based financial ratios; a few used cashflow- based measures. Comparison of the two approaches on the same dataset are rare. This study investigates the prediction accuracy of six accrual-accounting, six cash-flow-based, and the combined 12 ratios on companies’ financial data collected during the 2008-2010 recession. Careful to avoid prior research pitfalls (Sharma, 2001), we perform many analyses on a matched set of 50 failed and 50 nonfailing companies. We propose that cash-flow-based measures are better predictors but find that a mixed model of two accrual-accounting- and two cash-flow-based ratios perform significantly better than other models.