Ratio analysis and the prediction of business failure

Abstract

Economic survival was once merely a minor concern to business enterprises usually only new companies. However, as the current recession continues, survival is quickly becoming the dominant corporate objective. As businesses fail, they leave outstanding debts, unpaid employees, reduced government revenues, and dissatisfied owners, in addition to increasing unemployment. In 1981 alone there were over 8,000 corporate bankruptcies with liabilities in excess of 1.1billion dollars. with the number of failures increasing dramatically, models to predict survival become an important tool in managements' arsenal, and have developed from an ad hoc base to complex computerized techniques. Multiple Discriminate Analysis [HOA] is one of the latter, and attempts to quantify a company's "riskiness" into a "Z-score." These Z-scores can then be used in credit-worthiness decisions, and most importantly, predictions of economic survival. This paper discusses the history of ratio analysis, up to the current usage of Financial statement Information. In addition, a comparison is made between the predictive models developed by Edward Altman and Gordon Springate using American and Canadian data respectively. Finally, the paper discusses the limitations of this research, and suggests further areas of research.