The prediction of corporate failure using price adjusted accounting data

Abstract

This study sought to build a model to predict corporate failure using accounting data adjusted for price level changes. The need to predict failure before its actual happening need not be emphas ised given that its a "costly" outcome. The General

price level index was used to adjust the historical

data.

accounting

The sample consisted of 10 failed and 10 non-failed com- panies. The seemingly small sample was a consequence of lack of data availability particulary on the failed companies. This is surely one of the severe limitations of the study. Important financial ratios were calculated from price-level adjusted finan­ cial statements. The discriminant model developed from this data showed that nine ratios had a high corporate failure predictive ability. These I~atio's in order of importance were Times interest coverage, Fixed Charge coverage, Quick ratio, Current ratio,

Equity to total assets,

Working capital to total debt, Retained

earning to total assets, Change in monetary liabilities, Total debt to total assets and Inventory turnover. However the most critical ratios were the liquidity and debt

service ratios.