Financial statement analysis is described as the process of identifying financial strengths and weaknesses of the firm by correctly launching association between the items of the balance sheet and the profit and loss account. It is usually recognized that the objective of financial statements is to offer information about the financial position, performance and changes in financial position of an enterprise that is valuable to a wide range of users in making economic decisions. Again, financial statement analysis is the method of accepting the risk and profitability of a firm in the course of analysis of reported financial information, by using different accounting tools and techniques for evaluating and pricing credit risk and for doing fundamental company valuation. The financial strength of firms is of distress to numerous negotiators in society, including investors, bankers, governmental and regulatory bodies, and auditors. The credit rating of listed firms is a significant indicator, both to the stock market for investors to regulate stock portfolios, and in addition to the capital market for lenders to determine the costs of loan default and borrowing conditions for their clients. It is also the duty of government and the regulatory authorities to observe the general financial status of firms with the aim of make proper economic and industrial policy.
Further, auditors require examining the going-concern position of their clients to present a precise report of their financial standing. The failure of one firm can have an effect on a number of stakeholders, including shareholders, debtors, and employees. However, if a number of firms simultaneously face financial failure, this can have a wide-ranging effect on the national economy and possibly on that of other countries. There are lots of causes of corporate failure which include the liquidity, solvency and profitability position. In today’s economic climate overtrading can also create the risk of illiquidity and lead to corporate collapse.
A prediction is a report regarding the means effects will take place in the future, frequently but not constantly based on experience. Prediction is very much associated to uncertainty.
Financial distress is a situation where a company cannot meet nor has intricacy paying off its financial obligations to its creditors. The chance of financial distress increases when a firm has high fixed costs, illiquid assets, or revenues that are perceptive to economic downturns. Financial distress is a term in corporate finance used to point out a circumstance when promises to creditors of a company are broken or honored with difficulty. If financial distress cannot be relieved, it can lead to bankruptcy.
Financial distress is generally associated with some costs to the company; these are known as costs of financial distress. Now obviously question arises? How can financial distress be predicted? This question is of curiosity not only to managers but also to external stakeholders of a company. A good number research studies on company bankruptcy and failure predictions were prepared in developed countries for example those carried out by Beaver (1966), Altman (1968) in the United States, and Ganelasingam & Kumar, (2001) and Cybinski (2001) in Australia. Financial distress prediction happened to a significant accounting and finance research area since 1960s.
Based on the cash flow outline, Beaver carried out three different univariate Journal of Management Research analyses-profile analysis (comparison of mean values), dichotomous classification test and likelihood ratio analysis- so as to observe the predictive portrays and usefulness of each variable (Yu-Chiang Hu and Jake Ansell, 2006). By and large, financial distress leads business failure and downfall. Consequently, reviewing the financial trends and financial information of a business on a periodic basis, provides the analyst, important imminent with reference to the performance and position of the business and companies under review. A premature forewarning scheme replica to facilitate can predict distress and can provide signals of financial problems forward would probably be constructive in minimizing or absolute prevention of revelation to potential extensive failures for their own companies and shareholders or their clients. Based on a new trustworthy and perfect model Indian companies and beneficiaries might be benefited.
The objective of the present study is to build up a collapse prediction model using multiple discriminate analyses through unusual financial ratios to attain a better prediction accuracy rates for failed and non-failed companies for each of the five years before the date of the actual company failure.
Mr Udayan Karnatak, Lecturer, Amity Business School, Amity University Rajasthan