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The value of operating cash flow in modelling credit risk for SMEs

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  • Jairaj Gupta
  • Nicholas Wilson
  • Andros Gregoriou
  • Jerome Healy

Abstract

Small- and medium-size enterprises (SMEs) play a fundamental role in the economic performance of major economies especially in the light of the new Basel Capital Accord. Several lending communities proposed to treat SMEs as retail clients to optimize capital requirements and profitability. In this context, it is becoming critically important to have a detailed understanding of its risk behaviour for appropriate risk pricing. Evidence pertaining to SME financing strongly motivates us to believe that firms which are unable to generate sufficient operating cash flow (OCF) are more susceptible to bankruptcy. However, the role of OCF in bankruptcy of SMEs lacks empirical validation. We are the first to investigate the role of OCF information as predictors in assessing the creditworthiness of SMEs. 1-year distress prediction model developed using significant financial information of UK SMEs over a period 2000 to 2009 confirms that the presence of OCF information does not improve the prediction accuracy of the distress prediction model.

Suggested Citation

  • Jairaj Gupta & Nicholas Wilson & Andros Gregoriou & Jerome Healy, 2014. "The value of operating cash flow in modelling credit risk for SMEs," Applied Financial Economics, Taylor & Francis Journals, vol. 24(9), pages 649-660, May.
    • Handle: RePEc:taf:apfiec:v:24:y:2014:i:9:p:649-660
    DOI: 10.1080/09603107.2014.896979
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    8. Ariful Islam & Adil Mansoor & Mostafizur Rahman & Sazali Abd Wahab, 2020. "Adjusting A Strategic Cash-Flow Model For Bangladeshi Small And Medium Enterprises: The Art Of Surviving Covid-19 Emergency," Business Excellence and Management, Faculty of Management, Academy of Economic Studies, Bucharest, Romania, vol. 10(5), pages 194-213, October.
    9. Nyitrai, Tamás & Virág, Miklós, 2019. "The effects of handling outliers on the performance of bankruptcy prediction models," Socio-Economic Planning Sciences, Elsevier, vol. 67(C), pages 34-42.
    10. Gupta, Jairaj & Wilson, Nicholas & Gregoriou, Andros & Healy, Jerome, 2014. "The effect of internationalisation on modelling credit risk for SMEs: Evidence from UK market," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 31(C), pages 397-413.

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