Our Blog - Subject 4

(4) Analysis of Bankruptcy Probability

Do we have any tool to define the vulnerability of our company relative to future risk of bankruptcy? Can we know it with enough time to react? Moreover, in a group of companies or a corporation, would we be able to determine which companies have greater weight in the risk of bankruptcy of the whole?

 

Obviously we are most interested in knowing this information, but it is also very important for financial institutions to which we request financing, for potential investors, for our customers to know if we will be able to fulfill our commitments, etc.

 

In this subject we will see different indicators, based on discriminant analysis, reporting in advance about two years about the Probability of Bankruptcy of a company. Also we will get our report directly from a minimum data set of Financial Statements (Balance Sheet and Income Statement).

 

 

Simulator to calculate the Probability of Bankruptcy ...

 

Now, in a practical way, how to obtain a report of risk and probability of bankruptcy from some data located in our Financial Statements.

 

It's simple, just have to fill in correctly the information requested in the form below, answer the question of verification (this is to prevent saturation produced by the action of robots) and clicking the [ Get Report ] button ... in a few seconds the display will show a report in pdf format that we will be able to use freely.

 

 

We are loading the file generated from our servers ... Wait a moment, please.

 

 

The following links provide information to the doubts about the data to fill in: Balance Sheet and Income Statement.

 

Bankruptcy Analysis Models

 

Score-functions are based on statistical techniques of discriminant analysis, in our case, this means the observation of a group of companies through different financial ratios. The selected companies belong to two groups: healthy firms and companies at risk of bankruptcy.

 

Score-function is created from the linear combination of the chosen ratios, and identifies different cutoff values of the function for classifying the companies regarding their bankruptcy risk.

 

In the previous section we have obtained a report about Bankruptcy Probability providing some existing data in Financial Statements. Results obtained are based on two well-known bankruptcy prediction models: Altman and Conan et Holder.

 

• Altman Model - Index ' Zeta '

   

  In 1968 Edward Altman developed a model to predict the probability of bankruptcy of a company. It is based on the combination of five financial ratios obtained from Financial Statement; this combination provides a number that determines the financial health of the company, and early detection of potential difficulties and allowing, therefore, the search for solutions.

   

  The original model was applicable only to public entities that were publicly traded, so then developed a solution to apply the model to the private sector, the structure of the latter indicator, which is what we have implemented in our practical reports, we can see in the following image ...

   

   

  Edwar Altman checked, thirty years later, the complete validity of the model. Just keep in mind that this indicator was developed under a U.S. economic environment.

 

• Conan et Holder Model

   

  This model, which also uses discriminant analysis, was developed in France by Conan and Holder, therefore, under a central European economic environment. It allows us to determine (in percentage) the probability of a company in reaching a bankruptcy status.

   

  They observed 31 financial ratios in companies up to 500 employees, and they concluded that five of these ratios are the most important and decisive as to the calculus of bankruptcy probability. The final function developed and the table with the cut-off values are shown in the following image ...

   

   

 

• Some observations ...

  • The combination of different models of Bankruptcy Probability can be very useful to have an initial assessment of the vulnerability of a company. It is convenient to perform the calculations periodically and, if possible, even on a yoy.

     

  • Obviously the prediction of these indicators does not involve 100% success, not least because they have been developed in specific economic environments, so you have to take into account the economic reality of the environment where the company is located, and take this analysis predictive as a further step in the Business Analysis.

     

  • The bankruptcy risk analysis should also take into account macroeconomic and market variables, it is recommended to complete the proposed indicators, based on financial ratios, with non-financial indicators that depend on the economic environment of the company operating.

     

 

 

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