A study of the ability of cash flow data in predicting financial distress for Taiwan's food processing industry

Taiwan has been undergoing a dramatic industrialization transition in the last two decades: from a light-industry based economy to a more advanced industrial stage of economic development. In the 1980s seeking to expand export market, the Taiwan government decided to purse new policies of liberalization and globalization, which policies also opened its domestic market for foreign producers.; The new policies significantly cast impact upon the food processing industry in Taiwan. The competition from the low-cost countries, particularly the South East Asian countries such as Malaysia and Thailand, forced the domestic food processors in Taiwan to reduce prices faster than expected, and accordingly, their profit margin has been shrinking tremendously. As cash flows continued to decline, some domestic food processing companies turn to the Taiwan government for financial help. However, the government believes the main problem behind the struggle is the slow pace in developing new technologies, not cash flows.; The position of Taiwan's food industry is taken by the author and this paper deals with the issues whether the cash flow problems really have the ability to predict failures of companies? Can one foresee a company's financial distress by judging its cash flows.; In this paper, the author, hoping to examine the relationship between cash flows and corporate failures, conducted a statistical discriminant analysis of 47 food processors in Taiwan, 21 of them already bankrupt.; The discriminant analysis shows that cash flows and current ratios are highly related to corporate failures, while return on total assets and gross margin ratios are not good yard sticks to predict. The hit ratio of the function is 76.5 percent, higher than the proportional chance criterion of 56 percent.; Cash flows and, particularly, current ratios are two good variables in predicting the Taiwan food processing companies' financial future and the management in the industry should pay more attention to both variables. When the cash flow appears worsened or the current ratio begins to decline, it gives warning signal to the management on the future of the company.; In summary, poor cash flow indeed leads to financial distress eventually. In this paper, the statistical models shows poor cash flow and low current ratio are good indicators to predict corporate failures in two years in Taiwan's food processing industry. The government and the management should carefully watch the industry's cash flow position. (Abstract shortened by UMI.)...