How Financial Ratios Can Predict Failure Finance Essay

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1 Introduction

Financial crisis is the concrete embodiment of corporate failures. To study the causes of a listed company in financial distress and establish perfect, effective and operational early warning model not only has theoretical significance, but also has practical significance. With the scientific early warning model, a listed company can in time prevent and defuse financial crisis and improve the scientific nature of the crisis early-warning management; lenders (banks) will avoid high-risk loans; investors access to financial risk warning; government regulatory agencies can be with more effective and more scientific manner for market regulation, maintaining the stable operation of the market.

2 Literature Review

Beaver (1966) first proposed corporate financial early-warning analysis model, followed by many scholars in this field of research, research methods are also continually refined and improved. Among them is the landmark of Z-Score Discriminate model proposed by Beaver (1966) and Altman (1968, 1977), and the logic / probability of regression model proposed by Martin (1977) and Ohlson (1980). Zavgren (1985) and other scholars made further deepening. Aziz, Emanuel, and Lawson (1988, 1989) based on the cash flow model proposed company’s value comes from the operators, creditors, shareholders and the sum of the Government’s cash flow present value. According to the analysis of the paired data between bankrupt company and non-bankrupt company, they found that in the five years before bankruptcy, the two types of the company’s means of cash flow from operations and cash payments have a significant difference in average income. According to statistics, the most frequently used method for analysis of the financial distress is multiple linear discriminate analysis and logistic regression method. In recent years, many countries have begun to experiment with new methods of financial distress prediction and have made some preliminary results, such as the use of various neural network models, in an attempt to overcome the shortcomings of previous methods. Meanwhile, some scholars have tried to explore the basis of economic theory of the enterprise’s financial crisis, from the non-equilibrium theory, option pricing models and contract theory to analyze and forecast the financial crisis, and have achieved some results.

Throughout the status of research and application at home and abroad, classification methods to a multiple linear discriminate analysis (MDA) as the mainstream, this is the most effective method in the academic circles and the industry. However, this method has its own drawbacks, such as the more stringent assumptions that the MDA requests variables showed normal distribution and equal covariance matrix and linear independence, which are inconsistent with many practice, has been the controversial issues in this field of study on the quantitative analysis. In view of this, this article would try to ST, as defined in the British company is a sign of financial distress, using the financial data of listed companies to the mainstream method of MDA in the early warning of financial distress to make a comparative study, on the one hand, further test the empirical results of these two methods in the United Kingdom in the application;

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