financial stress prediction models
financial stress prediction models
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Contents
Introduction    2
Literature Review    2
Model 1 - William H. Beaver's Model    3
Model II Altman's Z score Model    7
Model III Blum Marc's Model    10
Company 1 - Application of Beaver Model on Companies Listed in Stock Market    11
Company 2 - Application of Beaver Model on Companies Listed in Stock Market    13
References    17
Introduction
In the era of technology disruption organisation are facing tremendous pressure to enhance the time to market as well as best packing of value offerings. In this dynamic era, every organisation has a likelihood to go into bankruptcy or in certain kind of financial distress. Therefore, we require accurate and reliable prediction models that are required for early warning system to anticipate any kind of financial distress. I have performed extensive research on different models for comprehending the financial distress which is perhaps accurate in predicting this distress through growth of company activities or changes in the external environment. Analysis to forecast the condition organisation is critical and objective to minimize the risk for the business. This is because of the external stakeholders are the biggest recipients of the firm like shareholders, auditors, government regulations as well as other stakeholders. Essentially, any prediction model to comprehend the financial distress leverages the early warning systems provided through external parties as well as to comprehend the condition of the organisation. This indicates accuracy of predictive measurement model which is required to predict the financial distress.
Literature Review
Organisation needs to be a growing concern, always delivering value to its shareholders. Financial distress refers to a scenario in which it is unable to meet the required obligations with respect to its creditors may be because of high fixed expenses or revenue subjected to economic downturns. According to research performed by Altman & Hotchkiss in 2006, the explained that the unsuccessful business enterprise that can be explained in different attempts to comprehend the formal process which can help in confronting the firm to categorize the different economic issues. For any public listed company whose financial details are presented in the public knowledge, once can comprehend the financial difficulties if they have experienced the following
· Reduction in Dividends
· Closure in Assets
· Loss in terms Bad Debts or sunk cost
· Turnover of the CEO
· Decrease in the price of stock
There were more than 79 failed firms that were identified from the Moody's Industrial Manual while working for a period of 1954 to 1964. Majority of these firms were operating in the manufacturing industries. Essentially, there are different methods to comprehend whether the company is undergoing a financial distress or not.
I. William H. Beaver's Model
II Altman's Z score Model
II Blum Marc's Model
Question of predicting the financial distress is not only of interest for senior leaders and management but also to external stakeholders of the company. These players are consistently looking for optimal solutions to forecast the performance such that they can rationalize their decisions that are taken at the ground level.
Model 1 - William H. Beaver's Model
The first model that we are going to discuss is the Beaver Model which was originated in 1966. Beaver explains that financial ratios can be very advantageous to predict failure in the firms, analyse the distress as well as bankruptcy prediction models. Bond defaults, bankruptcies, overdrawn bank accounts as well as firms that needs to omitted for payment of preferred stocks and dividends for failed organisations. According to Beaver Model, analysis of financial statement can be leverage to assess the likelihood of financial distress explaining the probability that company wouldn’t be able fulfil its debts. In present dynamic, financial statement is ubiquitous to comprehend wide variety of ratios as well as stakeholders like supplier, credit-rating agencies, banks, including trade suppliers all the others. The research on financial ratios is the predictor of financial distress can help in broadcasting the entire context by the virtue of likelihood of ratios. The Bayesian approach of forecasting the financial distress can be reviewed as the problem of assessing the likelihood of Financial Distress and conditional probability based on the ratios - P(FD|R). In coming to the estimate of the conditional probability of the financial distress, the possible events can be expressed. After financial ratios are assessed, overall assessments of the probability of financial distress and health can be constructed. The probability of the ratio is the likelihood of the observed numerical value that could appear as financially distressed - P(R|FD). The joint probabilities that have been allocated in the financial distress after the ratios are observed. Overall relationship that can be expressed in terms of odd ratios along with other probabilities
(Prior-Odd Ratio) * (Likelihood-Odd Ratio) = (Posterior -Odd Ratio)
Below we will find the list of ratios that is been tested by Beaver's Model that can be very beneficial for Predicting the failure of any firm or organisation
First Group - Ratios that determine the Cash-Flows
· Cash Flow to Sales
· Cash Flow to Net Assets
· Cash Flow to Gross Worth
· Cash Flow to Net Debt
Second Group - Net-Income Ratios
· Net Income to Overall Sales
· Net Income to Overall Assets
· Net Income to Net Worth
· Net Income to Overall Debt
Third Group - Debt to Overall Asset Ratios
· Current Liabilities to Overall Assets
· Long-Term Liabilities to Overall Assets
· Current plus long-term liabilities to cumulative assets
· Current plus long-term along with preferred stock to overall assets
Fourth Group - Liquid-Asset to Overall-Asset Ratios
· Cash to Overall Assets
· Quick Assets to Cumulative Assets
· Current Assets to Cumulative Assets
· Working Capital to Cumulative Assets
Fifth Group - Liquid-Asset to Current Debt Ratio
· Cash to Current Liabilities
· Quick Assets to Current Liabilities
· Current Ratio (Current Assets vs Current...