E.1 Introduction

Briefly, the Lambda index predicts whether a company will have sufficient cash and credit to survive. It is a ratio that was developed by professor Gary Emery of the University of Oklahoma to pinpoint relevant components of liquidity, i.e., short-term balances and available credit. It provides a measure of the likelihood that a company would become insolvent.

Unlike standard cash forecasts that rely on traditional balance sheet relationships where cash and non-cash items are not differentiated and ignore cash flows and unused credit, the Lambda index incorporates uncertainty about cash flows in the form of a sample standard deviation from those cash flows. Accordingly, the Lambda index can be used like a z value from the standard normal distribution table. The higher the Lambda index, the less the probability that cash requirements will exceed cash on hand. Thus, a Lambda index of 1.64 represents a chance of one in twenty that cash requirements will exceed cash on hand, a Lambda index of 3.00 indicates that there is about one chance in a thousand, a Lambda index of 3.29 indicates that there is about one chance in two thousand, and a Lambda index of 3.90 indicates that there is about one chance in a twenty thousand.

E.2 The Lambda Index Defined

For a given period, the Lambda...