Solvency, Financial ratios, Bankruptcy, Financial statements

Information Content of earnings, Earnings, Earnings Announcement, Price reaction

The article focuses on evaluating alternative accounting measures. The evaluation of alternative accounting measures is one of the most difficult tasks facing the accounting profession. According to this method, alternative measures would be evaluated in terms of their ability to predict events of interest to users of accounting data. The measure with the greatest predictive ability with respect to a given event would be considered the "best" measure for that particular purpose. Although a variety of accounting measures have been offered as predictors, little is known empirically about their relative predictive power. The examination of this area can be described by summarizing earlier investigation. The purpose of the earlier study was to discover how well financial ratios could predict failure relative to random prediction. The findings of the study were: based solely upon a knowledge of the financial ratios, the failure status of firms can be correctly predicted to a much greater extent than would be expected from random prediction. This evidence, together with other tests conducted, suggested that financial ratios can be useful in the prediction of failure for at least five years prior to the event.

Reviews the book "Business Financial Management," by Gilbert W. Cooke and Edwin Bomeli.

One criterion being employed by a growing body of empirical research is predictive ability. According to this criterion, alternative accounting measurements are evaluated in terms of their ability to predict events of interest to decision-makers. The measure with the greatest predictive power with respect to a given event is considered to be the best method for that particular purpose. Because the predictive ability criterion is currently being used and is likely to experience even greater use in the future, this article examines its origin, its relation-ship to the facilitation of decision-making, and the potential difficulties associated with its implementation. Knowing the origin of the predictive ability criterion is important in understanding what is meant by predictive ability and why it is being used in evaluating accounting data. The criterion is well established in the social and natural sciences as a method for choosing among competing hypotheses. The use of the predictive ability criterion presupposes that alternatives under consideration have met the tests of logic and that each has a theory supporting it.