The Value of Operating Cash Flow in Modeling Credit Risk for SMEs

Small and medium size enterprises (SMEs) play a fundamental role in the economic performance of major economies especially in 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 behavior for appropriate risk pricing. Evidence pertaining to SMEs 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 operating cash flow information as predictors in assessing the creditworthiness of SMEs. One-year distress prediction model developed using significant financial information of United Kingdom SMEs over a period of 2000 to 2009 confirm that the presence of operating cash flow information does not improve the prediction accuracy of the distress prediction model