Financial ratios

Running head: FINANCIAL MANAGEMENT ARTICLE

Financial Management Article

Name of Student

Name of Instructor

Date

Financial Ratios, Discriminant Analysis and

the Prediction of Corporate Bankruptcy

Purpose of the Article:

"The purpose of this paper is to attempt an assessment issue-the quality of ratio analysis as an analytic technique."

Scope of the Article:

"This paper evaluates the analytical quality of ratio analysis for its potential as a tool in predicting corporate bankruptcy."

Classification of the Article:

This is an empirical article. Meaning, the information and data was gathered from research.

Findings or Inferences of the Article:

Multiple Discriminant Analysis (MDA) is a statistical technique that makes it easy to classify and distinguish between two groups. But, the most important aspect is that you can analyze the entire variable instead of doing it individual.

Discernment Function and important ratios:

Working Capital/Total assets
Retained Earnings/Total assets
Earnings before Interest and Taxes/Total Assets
Market Value of Equity/Book Value of Total Debt
Sales/Total Assets

To establish the best possible model, 6 different tests were used, and these tests are:

Initial Sample
Results Two Years Prior to Bankruptcy
Potential Bias and Validation Techniques
Secondary Sample of Bankruptcy Firms
Secondary Sample of Non-Bankruptcy Firms
Long-Range Predictive Accuracy

These tests showed important and significant signs. One of the most important ones is that most of the changes that occurred between years 2-3 prior to their bankruptcy. These also concluded into what's called the Z-score.

The Z-score is a score that can predict which firms might go bankrupt.

Z-score > 2.99 "non-bankrupt firms"
Z-score < 1.81 "bankrupt firms"

Having a score in between these numbers is defined as "zone of ignorance".

Reference

Altman, E. I. (1968). Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy. The Journal of Finance, 23(4), 589-609.