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Profitability, Growth, and Different Flow Ratio Concepts: Implications for Failing Firms

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  • Erkki K. Laitinen

    () (Faculty of Business Studies, University of Vaasa)

Abstract

The objective is to develop a mathematical model of the firm to show the relationship between profitability, growth, and financial flow concepts especially under conditions for failing firms. It is assumed that revenue flows are generated by periodic expenditures growing at a steady rate. These revenue flows are described in terms of profitability (internal rate of return), growth, and time lag between invested expenditure and generated revenue flow. Three kinds of financial flow concepts are drawn: revenue-expenditure flow (quick flow), revenue-expense flow (earnings), and cash flow. Earnings are drawn for three depreciation theories: proportional, rate of return, and compound interest depreciation. For each concept, flow ratios are drawn and compared with each other. Theoretical results are illustrated by empirical data from Finnish non-failing and failing firms.

Suggested Citation

  • Erkki K. Laitinen, 2012. "Profitability, Growth, and Different Flow Ratio Concepts: Implications for Failing Firms," Review of Economics & Finance, Better Advances Press, Canada, vol. 2, pages 112-130, November.
  • Handle: RePEc:bap:journl:120410
    as

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    References listed on IDEAS

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    1. Robert C. Merton, 2005. "Theory of rational option pricing," World Scientific Book Chapters,in: Theory Of Valuation, chapter 8, pages 229-288 World Scientific Publishing Co. Pte. Ltd..
    2. Venter, Gary G., 2007. "Generalized Linear Models beyond the Exponential Family with Loss Reserve Applications," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 37(02), pages 345-364, November.
    3. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
    4. Duffie, Darrell & Singleton, Kenneth J, 1999. "Modeling Term Structures of Defaultable Bonds," Review of Financial Studies, Society for Financial Studies, pages 687-720.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Profitability; Growth; Financial Flows; Ratios; Cash flow; Steady model; Failing firms;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • C65 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Miscellaneous Mathematical Tools

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