Importance of Business Cycles in Accounting Number Distributions; Empirical Evidence with Finnish Data

Ilkka Virtanen and Paavo Yli-Olli

Summary

The purpose of this study is to analyze the cross-sectional distributions of twelve common financial ratios and to model the time-series behavior of these rations during different business cycles. The selected ratios represent four a priori ratio categories: liquidity, long-term solvency, profitability and efficiency of the firms. The analysis shows that all the ratios can be made normally distributed. Some are already normal in the raw data form (profitability ratios), while the rest are originally positively skewed and need a square- root transformation (liquidity ratios, solvency ratios, and efficiency ratios). Removal of some outliers is also typically needed; their existence is highly dependent on business cycles. Among efficiency ratios, a division of the sample into two sub-samples (according to industry classification) is needed to obtain the desired result. The discovery that it is possible to model the most important first moments of ratio distributions with a business cycle index as their explanator emphasises the importance of business cycles in ratio distributions.

Key words: Distributions of financial ratios; Transformations; Outliers.

(A Spectrum of Statistical Thought. Essays in Statistical Theory, Economics and Population Genetics in Honour of Johan Fellman, 245-276, Helsinki 1991.)