2016

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Browsing 2016 by Author "Nawal Nasir"

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    Predictive Power of Bankruptcy Models
    (UMT,Lahore, 2016-04-20) Nawal Nasir
    Among various imputed objectives of an entity, the most important is the survival of the firm which is based upon the soundness of the profitability and financial health. The recent global financial crises have witnessed failures of many venerable organizations. There have been important developments in the area of corporate financial distress and bankruptcy since 1960s. Numerous studies have been conducted regarding early prediction of bankruptcy worldwide but in Pakistan it is an evolving area of research. Pakistan has an emerging economy. Since last twenty years, numerous cases of bankruptcy have been arisen in Pakistan. Hence, the need of the hour is to develop a bankruptcy prediction model which would be unique to the corporate environment of Pakistan. This study will try to identify an effective mean to ascertain the likelihoods of a firm collapsing. This study will help in developing and understanding for managers which of failure prediction model is adequate in forecasting bankruptcy. Relying on such model it will be possible to know the fitness of the business and tackle management deficiency prior to going bankrupt. Threat of bankruptcy can be ascertained before its occurrence. Remedies can be made in order to escape disaster. The research indicates that original Altman Z score predicts the probability of bankruptcy more accurately (95%) as it predicts 43 out of 56 ongoing companies as a continuing venture not in 2012 but all five years. In case the Altman model showed any company in yellow zone or grey zone, a careful examination is conducted of each and every variable on which the Z score is consisted, in order to assure the reliability of the prediction. Z score is based on seven important variables namely Working Capital (WC), Total Assets (TA), Retain Earnings (RE), EBIT (Earnings Before Interest & Tax), MVE (Market Value of Equity), BVD (Bank Value of Debt) and Sales. All these variables have significant influence on the performance of a company. The vigilant inspection proved that management improved the entire individual variables and made them satisfactory, and this practice caused upraise in Z score. The analysis showed 53 out of 56 successfully continuing were predicted accurately by Altman Z score. 3 companies have issue of type II error because they are still surviving although it was indicated as potential bankrupt for consecutive three years. The rule of thumb was it should be gone into bankruptcy within two years, right after the first year when formula predicted it as a probable bankrupt. Hence, Altman Z score is predicting the ongoing companies as 95% accurately in the economic setting of Pakistan. Moreover this study concludes that Ohlson O-score is not applicable for predicting possibility of bankruptcy in economic atmosphere of Pakistan as its accuracy of prediction is only 61% which is not enough to rely on. So, in Pakistan Altman Z score is a good indicator of a company’s ability to avoid bankruptcy.