Predicting Corporate Failure: Empirical Evidence for the UK

The main purpose of this study is to examine the incremental information content of operating cash flows in predicting financial distress and thus develop reliable failure prediction models for UK public industrial firms. Neural networks and logit methodology were employed to a dataset of fifty-one matched pairs of failed and non-failed UK public industrial firms over the period 1988–97. The final models are validated using an out-of-sample-period ex-ante test and the Lachenbruch jackknife procedure. The results indicate that a parsimonious model that includes three financial variables, a cash flow, a profitability and a financial leverage variable, yielded an overall correct classification accuracy of 83% one year prior to the failure. In summary, our models can be used to assist investors, creditors, managers, auditors and regulatory agencies in the UK to predict the probability of business failure.