A Study Of The Relationship Between Credit Risk And Cash Flow Variation

For the credit rating in Taiwanese firms, there are TCRI (Taiwan Corporate Credit Risk Index) announced regular from TEJ (Taiwan Economic Journal), it is an acknowledged and impartial institution in Taiwan since 1995. After made a thorough inquiry on TCRI, I found TCRI used 10 financial ratio which be adopted from Balance Sheet and Income Statement only, these ratios also be weighted and synthesized to sum up a rating score finally. But the cash flow variables haven't been into account when they decide a score yet.This study conducts a new test of the usefulness cash flow variation for explaining future firm's credit risk. The purposes of this study is to determine whether adding cash flow variation in prediction of credit risk model can improve the predictive ability, and also to assess the differential ability of aggregated cash flow variable to signal the future credit risk be Cash Flow Lending (as Low Credit Risk Firm) or Assets Lending (as High Credit Risk Firm).This study obtained 1036 samples from 2001 to 2004, excluding utility companies and firms in the finance and banking industries because of their unique accounting conventions, then used these samples to divide into two groups as'Low Credit Risk firm'and'High Credit Risk firm', next to develop Logistic Regression Model. Furthermore, this study also using T-testing method and Pearson correlation coefficient statistic to verify more efficient explaining ability of utilizing cash flow variation.The empirical results show that: (1) totally 4 items variable vs. credit rating are a certain appearance on Negative Relationship including CFO ( cash flow from operations),CFF(cash flow from financial),Profit Margin and scale of the firm; (2) adding cash flow variation(such as CFO,CFI),Profit Margin and scale of the firm into the prediction model can be effectively increase the predictability ability, specially to differentiate between the low and high credit risk firms.