Liquidity ratios and corporate failures

Abstract One of the most widespread claims in financial statement analysis is that liquidity ratios are useful for predicting failures. However, academic research has found surprisingly little empirical support for this claim. Using logistic regression splines, a non‐parametric method, this paper finds that the relation between the current ratio and failures differs significantly depending on the level of the current ratio. At low, but not high levels, the current ratio is significantly negatively related to failure. Incorporating such context provides statistically and economically significant predictive power about failures. These findings help resolve the discrepancy between practitioners and the academic literature.