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Wednesday, February 08, 2006

Financial Statements Are Still Valuable Tools for Predicting Bankruptcy

Despite growing public skepticism over how useful financial statements are in providing information to investors, researchers at Stanford’s Graduate School of Business have found that the value of financial ratios for predicting bankruptcy has not declined significantly over time.

Professors Maureen McNichols and William Beaver and graduate student Jung-Wu Rhie have reexamined the usefulness for predicting bankruptcy of financial ratios such as return on assets (net income divided by total assets), cash flow to total liabilities (earnings before interest, depreciation, and taxes divided by both short- and long-term debt), and leverage (total liabilities to total assets). The study explored how three forces have influenced this predictive value over the past 40 years.

The first force is that standard-setting bodies such as the Financial Accounting Standards Board and the Securities and Exchange Commission have been trying to increase the usefulness of the information found in financial statements and to enhance the ability of such statements to convey the fair value of assets and liabilities.

posted by Brian Moran @ 3:25 PM   0 comments


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