The Usefulness of Aggregated and Disaggregated Cash Flows in Signaling Financial Distress

Abstract

This study compares the incremental usefulness of aggregated net and disaggregated gross cash flows in signaling future firm financial distress. Our study extends previous research because we used actual reported, rather than estimated, cash flows. This study examines a sample of nondistressed firms and firms that became financially distressed in 1991 and 1992 to generate logistic regression models. Logistic regression models were generated to predict a separate holdout sample of 1993 firms. Results show that cash flows have incremental usefulness in explaining financial distress. However, aggregated net cash flows do not capture all the information provided by disaggregated gross cash flows. The only aggregated cash flow useful in signaling future financial distress is net cash flow from operating activities. Several disaggregated gross cash flows are also useful in signaling future financial distress. The two most important disaggregated gross cash flows in signaling future financial distress are taxes paid and interest paid.

JEL Classification: M41, G33