Financial Analysis Tools for Evaluating Bankruptcy Risk
Discuss About The Corporate Governance Indicators Bankruptcy.
Predicting the bankruptcy was an on-going concern of the researchers and lately it has become subject extensively studied the process and controversial discussion. Financial analysis is the process to evaluate the past and future performance of company. If person wants to evaluate the financial performance of company then they will have to use the financial statements such as balance sheet, profit and loss statements and other details. After that financial analysis tools will be used to evaluate the profitability, efficiency, solvency and market ratio to identify the past and future performance of company. Sign of the business failure are the main usual evident long before bankruptcy. It is analyzed that if investors use proper analysis tools then they could easily determine whether company has been facing any financial leverage in its business or not. Ideally, bank faces bankruptcy when it has higher solvency ratio or the profitability of company is not adequate enough to cover its fixed charges and expenses. There are number of methods and financial tools which are used to assess whether the bank will be sustainable in the long run or not.
There are thousands of companies have been facing the financial distress and difficulties which in many cases lead to bankruptcy. After analysing the cases of the corporates scandals, it could be inferred that these numbers have increased due to the increased financial leverage.
As stated by Yu, Miche, Séverin, and Lendasse, (2014), it is divulged that the indication of the bankruptcy or liquidation of company is highly based on the solvency of the company and its profitability earning capacity. Solvency is related with the financial capital structure of the company. The financial structure of company is accompanied with the debt and equity of the company. It is analyzed that if company could manage the proper business structure then it could reduce the chances of the solvency risk of the business. Ideally, the solvency risk of the company is based on the increased debt portion and interest payment of organization (Wahlen, Baginski, and Bradshaw, 2014).
As stated by Zi?ba, Tomczak, and Tomczak, (2016), it is reflected that the major corporate collapses are the ABC learning, One Tel Company and HIH Insurance who have been dissolved due to the business functioning. It is observed that if the management of these companies used the proper financial analysis tools then it would have resulted to the suggestion of the financial performance of companies. The financial data such as total revenue, profitability, debt to equity ratio had been showing at that time that company has less efficiency to meet its corporate responsibilities and failed to manage its business in long run. Company is set up with a view to set up separate legal entity. It is analyzed that if in order to manage the proper strategic business functions, management needs to implement the proper strategic program. As per the views of Altman, Iwanicz-Drozdowska, Laitinen, and Suvas, (2015), it is reflected that the Capital budgeting tools is another method to evaluate how the investment in the particular project will give more return to company. In one Tel company, management had to face high loss due to the less transparency and non-effective reporting frameworks. It will not only resulted to the dissolution of company but also lower down the outcomes of the business. It is further observed that financial statements of company could only divulge the possible financial information which could be qualified and non-qualified information. If investors want to assess the present and future financial performance then they will have to consider the share price performance, solvency and profitability of company. However, ratio analysis is the basic tool which is used to assess the financial performance and future business practice of company. For instance, the current ratio of company divulges the ability of company to pay off its short term and long term debts out of the available current assets. In addition to this, profitability ratio shows the company’s ability to earn profit from its turnover. It shows the return on capital employed, return on assets, return on share capital (Liang, et al., 2016). After that, investors and management department could assess the efficiency of company to run the business. As stated by Gupta, Gregoriou, and Healy, 2015. It is divulged that it will not only showcase the efficiency of company to deploy the cash funds but also reflects how well Particular Corporation has used its capital. Ideally, corporate scandals and liquidating cases have emerged due to the less transparent business functions and complex business structure. Each and every company needs to establish the proper harmonization in its domestic and international reporting framework to strengthen its transparency of the business. It is analyzed that the financial diagnosis by the bankruptcy risk rate analysis and risk assessment considers the primarily on three important dimensions of firm: profitability, liquidity and financial structure.
Corporate Scandals and Bankruptcy
As stated by Lakshmi, Martin, and Venkatesan, (2016), it is reflected that the failure of the business in the market and increased financial distress has happened due to the less effective business functions and non-efficient management program of company. Managers are the key persons of the company who takes all the strategic decisions. If they fail to take effective decisions then it will not only impact the business but also increase the financial risk of company in long run. Ideally, the financial risk of company is highly dependent upon debt capital and profitability of company. For instance, if company is having high profitability then it could have higher financial leverage in its business. Ideally, financial scandals arise when company fails to meet its short term and long term responsibilities. It is evaluated that mangers need to have proper financial information about the company to make the strategic financial decisions (Iturriaga, and Sanz, 2015). It is analyzed that the ratio analysis is ideally used by the managers to establish the relation between the two financial factors and evaluate whether the implemented decisions will add value to the clients satisfaction or not. It is further observed capital budgeting tools such as NPV, IRR and profitability index are the key to analysis whether company should invest their capital in particular project or not. In addition to this, company also needs to analysis whether investing capital in the particular project will have more output or not. Managers need to only accept those projects which gives higher project benefits to the organization. All the financial information shown in the annual report or financial statement of company needs to be analyzed whether investing capital in the particular project will create value on the investment or not. All the financial and non-financial information such as employee turnover, market share, profitability and financial leverage of company are the key indicator to determine whether company has strong financial position in the market or not. This research has reflected that how financial ratio could have different bankruptcy- indicating abilities across industries and time. The main goal of this research is to estimate models in such a way whether it could prevent company from happening of negative outcomes (Altman, et al. 2014). Corporate default and failure is often associated with the potential negative events in the particular situation when credit risk is present. According to the Finance and Banking (Oxford Reference, 2012), default could be defined as failure to make the required payment. Ideally, a bank goes into liquidation when company fails to make the proper payment to its creditors. This liquidation and dissolving problems arise due to the distress of the work process system of organization. Management could use this financial and non-financial information as indication for their business failure. For instance, if company fails to meet its set targets in the given time manner or having the deficiency of the resources then it will showcase the negative indicator for the future growth of the business management. Therefore, mangers should use this information to prepare the proactive strategic plan which will further add value for the better work satisfaction of the organization (Abdullah,., 2016).
Ratio Analysis and Decision Making
As stated by Calabrese, Marra, and Osmetti, (2016), it is divulged that the analysis of the financial data and non-financial data is based on the two important factors such as rate of return of business and economic rate of return. The rate of return of company shows the return earned by company from its business and on the other hand, economic rate of return divulges the allocation of the capital for the productive activity of the enterprise and are commonly used for analysis between firms in the same sector or different sectors irrespective of the size and invested capital.
As per the views of Zainudin, and Hashim, (2016) it is analyzed that in order to determine the bankrupt company and at what condition company goes into liquidation, it is first required to read the bankruptcy rule and regulations. These rules and regulations are used to assess the failure of companies, its negative outcomes on the business and restricted business practices in the business. If company does not take into account the proper methods and work process system then it will lead to liquidation of company. In case of the bankruptcy and liquidation of company, it is analyzed that company fails to pay off its debts and creditors are filling case against the company for their debt funding. It is observed that if managers could know their future expectation and responsibilities in long run then they could easily set up proper work functions program to arrange capital for their business.
As stated by Aris, et al, (2015) it is reflected that the Z score approach is used to analysis the methods of measuring and interpretation of the risk to which investors who invested capital and enterprises exposed.
This measurement is used for development of value judgments that linear combine a group of financial ratios or of significant variables.
The score functions are accompanied with the following details
: Z = a1*X1 + a2*X2 + a3*X3 + … + an*Xn
(Almamy, Aston, and Ngwa, 2016).
As per the views of the Kim,. Kang,. and Kim, (2015) it is reflected that there are ideally two credit risk models which could be used to assess the financial performance and future outlook of the business in long run. The first group consists of accounting based models which predict the corporate failure estimation of the reason of the failure of these companies. The other model group consists of the market based model in which the market entries and future perspective of the future will be undertaken for the better handling of the cases. As per the views of Mohammed, (2016), it is divulged that the credit risk models are used to assess the whether the existing resources of the company will be enough to meet the future responsibility of the company. If managers identify the issues and problems faced by company then it will add value for the handling the financial distress issues and also prepare company for the financial management in determined approach (Ballings, Van den Poel, Hespeels, and Gryp, 2015).
Capital Budgeting Tools and Investment Decision Making
As stated by Tian, Yu, and Guo, (2015) it is divulged that there is another two models named Altman’s Z score Model and Olson’s Model which could be used to strengthen the work process and increase the overall outcomes of the business. If company uses these models then they could easily determine the future perspective and its current ability to meet its liabilities. However, with the changes in the ramified economic condition, Ohson’s model is used to evaluate the financial ratio of company and establish the linkage between the existing assets. It set up the proper work functions and determines whether the company could arrange the finance for its future financial resources or not. As per the views of Ehiedu,(2014), it is reflected that the financial ratio divulges the capacity of the business and also shows whether the company could meet its future liabilities or not. In addition to this, management also needs to assess the non-financial information such as credit disclosure rule and liquidation rules and regulation. Managers need to evaluate when and how company goes in the liquidation. These are the main factors which make managers more proactive towards restricting the situation of the liquidation.
As per the views of Jan, and Marimuthu, (2015) it is divulged that managers are the key managerial persons who take all the key imperative decisions. It is analyzed that proper management strategies and strategic programs to maintain the effective work structure in determined approach. The bankruptcy and liquidation of the organization is dependent upon the management strategies and financial strategic planning. If company could manage the proper financial strategic planning in its business then it will add value for the sustainable business strategies.
As stated by Ishibashi, et al. (2017) this could be illustrated with the given example that in One Tel Company, managers could have identified the financial risk of the business which company faced due to the non-efficient business functioning. They could have used the debt to equity structure and profitability ratio of business. The financial statement of One Tel Company reflected only thorough information regarding the financial and non-financial information of the business. The financial statement could only divulge the present and future outcomes of the business. However, managers could have used the financial analysis tools such as ratio analysis, capital budgeting, du Pont analysis and top down analysis to evaluate the deficiency and possibility of the non-effective business functioning.
The Importance of Financial Information
References
Abdullah, A.A., 2016. Financial Statement Analysis for Kier Group PLC. Global Journal of Management And Business Research.
Almamy, J., Aston, J. and Ngwa, L.N., 2016. An evaluation of Altman’s Z-score using cash flow ratio to predict corporate failure amid the recent financial crisis: Evidence from the UK. Journal of Corporate Finance, 36, pp.278-285.
Altman, E., Iwanicz-Drozdowska, M., Laitinen, E. and Suvas, A., 2014. Distressed Firm and Bankruptcy Prediction in an International Context: A Review and Empirical Analysis of Altman’s Z-Score Model.
Altman, E.I., Iwanicz-Drozdowska, M., Laitinen, E.K. and Suvas, A., 2015. Financial and non-financial variables as long-horizon predictors of bankruptcy.
Aris, N.A., Arif, S.M.M., Othman, R. and Zain, M.M., 2015. Fraudulent financial statement detection using statistical techniques: The case of small medium automotive enterprise. Journal of Applied Business Research, 31(4), p.1469.
Ballings, M., Van den Poel, D., Hespeels, N. and Gryp, R., 2015. Evaluating multiple classifiers for stock price direction prediction. Expert Systems with Applications, 42(20), pp.7046-7056.
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Ehiedu, V.C., 2014. The impact of liquidity on profitability of some selected companies: The financial statement analysis (FSA) approach. Research Journal of Finance and Accounting, 5(5), pp.81-90.
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Ishibashi, K., Iwasaki, T., Otomasa, S. and Yada, K., 2017, October. Model selection for financial statement analysis: Comparison of models developed by using data mining technique. In Systems, Man, and Cybernetics (SMC), 2017 IEEE International Conference on (pp. 81-86). IEEE.
Iturriaga, F.J.L. and Sanz, I.P., 2015. Bankruptcy visualization and prediction using neural networks: A study of US commercial banks. Expert Systems with applications, 42(6), pp.2857-2869.
Jan, A. and Marimuthu, M., 2015. Altman model and bankruptcy profile of islamic banking industry: A comparative analysis on financial performance. International Journal of Business and Management, 10(7), p.110.
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Lakshmi, T.M., Martin, A. and Venkatesan, V.P., 2016. A genetic bankrupt ratio analysis tool using a genetic algorithm to identify influencing financial ratios. IEEE Transactions on Evolutionary Computation, 20(1), pp.38-51.
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