project report

EXECUTIVE SUMMARY

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A company failure or bankruptcy model based on multiple discriminatory analysis developed by Prof. Edward Altman of New York University in 1968. This Z Score model combines five different financial ratios: [(networking capital)/ (total assets), (retained earnings)/ (total assets), (earnings before interest and taxes)/ (total assets), (market value of common and preferred)/ (book value of debt), (sales)/ (total assets) to determine the likelihood of bankruptcy amongst companies. Firms that have a Z-Score more than 3 are considered to be healthy and, therefore, unlikely to enter bankruptcy. Z-Scores in between 1.8 and 3 lie in a gray area.

The analysis of a firm’s financial statements is undertaken with the purpose of extracting significant information relating to firm’s objectives, profitability, efficiency and degree of risk. This is achieved by using ratios relating to key financial variables and analysis of the statements and the notes relating there them. Because ratio analysis employs financial data taken from the firm’s balance sheet, statement of retained earnings, and income statement, these reports and their interrelations must be mastered to fully understand the significance of the various financial ratios (Betker, 1995). The basic financial statements include: A. Balance sheet, which shows the firm’s financial position at a specific time.

Assets: 1. Assets arranged in order of liquidity 2. Current assets converted to cash within one year or operating cycle whichever is longer. 3. Fixed assets tangible resources of a relatively permanent nature that are being used in the business and not intended for sale.

Claims: 1. Current liabilities must be paid off within one year or operating cycle whichever is longer, 2. Long-term debts with maturity greater than one year. 3. Stockholders equity represents ownership of the firm.

B. The income statement reports the income and expenses of operations during a period of time.

C. The statement of retained earnings shows the amount of net income reinvested in the business.

1. Retained earnings shows the amount of net income reinvested over a period of years. 2. Retained earnings are not usually held in cash, but invested in other assets of the firm.

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Altman concluded:

The original Z-score formula was as follows:

Z = 0.012T1 + 0.014T2 + 0.033T3 + 0.006T4 + 0.999T5.

T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.

T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.

T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.

T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.

T5 = Sales/ Total Assets. Standard measure for sales turnover (varies greatly from industry to industry).

Z-score < 1.81 = high probability of bankruptcy. Z-score > 3.0 = low probability of bankruptcy. Z-score 1.81- 3.0 = indeterminate. For the study purposes the researchers used:

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OBJECTIVES

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1 To study the performance of financial position of the company.

2 To analyse the financial tools like working capital management, ratio analysis and Z score test to be applied.

to develop explanations for short term financial fluctuations

to predict the financial results in their firm for near future.

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INTRODUCTION

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IntroductionThe major issue arising in the present times, for both management academics andpractitioners, relates to the principles which determine corporate successes and failures that iswhy some organization prosper and grow while other collapse. The often unexpectedcollapse of large companies during the early 1990’s and more recently in 2002 has leadanalysts to look for ways of predicting company failure. Corporate failures are common incompetitive business environment where market discipline ensures the survival of fittest.Moreover, mismanagement also leads to corporate failure. Predicting corporate failure isbased on the premise that there are identifiable patterns or symptoms consistent for all failedfirms.

The models to predict Corporate Failure:Several techniques have been developed to help predict why companies fail. However, theseare not accurate and do not guarantee that the prediction will turn out to be true. These modelsare The Z-Score, Argenti Model, and the VK model amongst others.Beaver was one of the first researchers to study the prediction of bankruptcy using financialstatement data. The established practice for failure prediction is therefore a model based onfinancial ratio analysis. Published financial reports contain a great deal of information about thecompany performance and prospects. Therefore, ratio analysis is not preferred for financialaccounts interpretation however; it has also played a central role in the development ofbankruptcy prediction models.The Altman Model: Z-ScoreThe Z-Score model is a quantitative model developed by Edward Altman in 1968, to predictbankruptcy or financial distress of a business. The Z-score is a multi variate formula thatmeasures the financial health of a company and predicts the probability of bankruptcy within 2

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years. This model involves the use of a specified set of financial ratios and a statistical methodknown as a Multiple Discriminant Analysis. (MDA). The real world application of the Altmanscore successfully predicted 72% of bankruptcies two years prior to their failure.The model of Altman is based on a linear analysis in which five measures are objectivelyweighted and summed to arrive at an overall score that then becomes the basis forclassification of companies into one of the two a priori groupings that is bankrupt or nonbankrupt.These five indicators were then used to derive a Z-Score. These ratios can beobtained from corporations’ financial statements.

FINANCIAL ANALYSIS DEFINITION: Financial data analysis is a basis for understanding and evaluating the results of business operations. In addition, financial statement analysis can help creditors, investors, and managers answer the following questions: Can the company pay the interest and principal on its debt? Does the company rely too much on non-owner financing? Does the company earn an acceptable return on invested capital? Is the gross profit margin growing or shrinking? Does the company effectively use non-owner financing? Are costs under control? Is the company’s market growing or shrinking? Do observed changes reflect opportunities or threats? Is the allocation of investment across different assets too high or too low? Therefore, financial analysis may be defined as “the judgmental process which aims to evaluate the current and past financial positions and the results of operations of a firm, with the primary objective of determining the best possible estimates and predictions about future conditions and performances”

Financial analysis provides the basis for understanding and evaluating the results of business operations and explaining how well a business is doing. In addition, the financial statement analysis can help creditors, investors, and managers answer the following questions: Can the company pay the interest and principal on its debt? Does the company reply too much on non-owner financing? Does the company earn an acceptable return on invested capital? Is the gross profit margin growing or shrinking? Does the company effectively use non-owner financing? Are costs under control? Is the company’s market growing or shrinking? Do observed changes reflect opportunities or threats? Is the allocation of investment across different assets too high or too low? Furthermore, financial statement analysis reduces our reliance on hunches, guesses, and intuition. Above all, it reduces risk and/or uncertainty in decision making. Therefore, to reduce risk, uncertainty, and avoid bankruptcy one must appreciate the usefulness of

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financial statement analysis by using some tools and techniques to evaluate and project the future performance of the firm within a given industry.

Financial Performance

Performance is always measured over a time period. Corporations typically report their performance on a quarterly basis. Internally, companies track their performance on a monthly basis (some companies may even do this weekly or daily - or at least track certain performance figures, like sales, on a frequent basis). The so-called Annual Report is a requirement (imposed by governments and securities regulators) whereby firms disclose their financial results on an annual basis - along with various other bits of information which may be of value to shareholders.

The most important measure of performance is the Bottom Line. This is called the bottom line because it is the bottom line which appears on a Profit and Loss Statement, also called an Income Statement. The bottom line shows the amount of Net Profit (after taxes have been paid) which the business has generated during that particular reporting period. This number reports what the company has earned during the stated period of time. These earnings are sometimes stated on a per share basis. This allows one to compare to other companies by comparing their respective Price/Earnings ratios. Or, one could compare companies by comparing their respective earnings expressed as a percentage of sales or as a percentage of capital invested. For example, company ABC's earnings were 6% of revenues as compared to 5% for the industry average. Or ABC's return on investment for the period was 25% (i.e. earnings as a percentage of capital invested) as compared to its main competitor which only returned 22% to its investors.

There are also non-bottom line numbers which are often important and need to be studied. These would include gross margins (percent gross profit) or perhaps various expenses, such as Research and Development expressed as a percentage of sales. If we are producing communications systems with gross margins of 45% and R+D expenditures of 9% and our competitor is achieving gross margins of 52% and R+D expenditures of 8%, we better figure out what we're doing wrong.

In making comparisons to other companies, one should be careful not to compare apples with bananas (like comparing Apple to Microsoft). The companies should be in the same business (e.g. systems, software, hardware, communications, etc, etc). In any event, depending on our management position in the organization, we will focus on those performance measures which are important to us. The sales manager will be sensitive to overall sales, sales expenditures, and gross margins. The production manager will be concerned with cost of sales, gross margins, and operating expenses. The VP Engineering will be concerned with development costs, unit costs, and margins. And, the CEO will worry about everything.

Financial Health

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A company's financial health is measured by taking a snapshot of its assets and liabilities at one moment in time, usually at the end of a reporting period - such as at the end of a quarter or fiscal year (what's a fiscal year?). How much cash is in the bank? How much is owed by the customers? What are the debt obligations - to banks, suppliers, and others? How much capital has been invested? How much has the company earned (or lost) to date (this item comes from the Profit and Loss statement and is called retained earnings - that is the company's total earnings (net of any dividend payouts) since its inception.

Financial Health is reported on the company's Balance Sheet. Balance Sheets and Profit and Loss statements must always be considered together. One measures health and the other measures performance.

Just as blood flows through the veins of a person, cash flows through the veins of a company. Although a company's balance sheet may look strong (i.e. lots of assets and few liabilities), the most important asset is cash and short term deposits, followed by cash to be realized within one month (e.g. getting paid on recent sales). The cash-on-hand obtained from the balance sheet can be divided by a company's monthly expenses to determine a rough estimate of how long the company can survive at its current level of operation. Developing companies, such as biotech ventures, generally have sufficient cash on hand that they can operate for years before having to generate income from sales. 

INDICATORS OF FAILURE

In general failure is either: Economic – A firm’s revenues do not cover costs. Financial – Financial failure signifies insolvency, and we have: 1. Technical insolvency, when a firm cannot meet its current obligations as they come due even though its total assets may exceed its total liabilities. 2. In bankruptcy sense, if firm’s total liabilities exceed its total assets, the net worth of the firm is negative.

Symptoms of corporate failureThere are three classic symptoms of corporate failure. These are namely:1. Low profitability2. High gearing3. Low liquidityEach of these three symptoms may be indicated by trends in the company’s accounts.Symptoms are interrelated. The classic path to corporate failure starts with the companyexperiencing low profitability. This may be indicated by trends in the ratios for:Profit margin

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Return on Capital ExpenditureReturn on Net AssetsA downward trend in profitability will raise the issue of whether and for how long the companycan tolerate a return on capital that is below its cost of capital. If profitability problems becomepreoccupying, the failing of the company may seek additional funds and working capital byincreasing its borrowings, whether in the form of short term or long-term debt. This increasesthe company’s gearing, since the higher the proportion of borrowed funds, the higher thegearing within the capital structure. The increased debt burden may then aggravate thesituation, particularly if the causes of the decreasing profitability have not been resolved.The worsening profit situation must be used to finance an increased burden of interest andcapital repayments. In the case of a publicly quoted company, this means that fewer and fewerfunds will be available to finance dividend payments. It may become impossible to obtainexternal credit or to raise further equity funds.Confidence in the company as an investment may wither away leaving the share price tocollapse. If the company is sound, for instance, but ineptly managed, the best that can behoped for is a takeover bid for what may be now a significantly undervalued investment.At this point, a company may not be really failing but unfortunately, more often rescue attemptsare not mounted. This may be because the company’s management does not recognize theseriousness of the situation, or is by now too heavily committed or too frightened to admit thetruth to its stakeholders, when refinancing is attempted profits fail to cover payments leading toa cash flow crisis.CAUSES OF CORPORATE FAILURE AND THEIR EXAMPLES :Technological causesTraditional methods of doing work have been turned upside down by the development of newtechnology. If within an industry, there is failure to exploit information technology and new

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production technology, the firms can face serious problems and ultimately fail.By using new technology, cost of production can be reduced and if an organization continuesto use the old technology and its competitors start using the new technology; this can bedetrimental to that organization. Due to high cost of production, it will have to sell its productsat higher prices than its competitors and this will consequently reduced its sales and theorganization can serious problemsThis situation was seen in the case of Mittal Steel Company taking over Arcelor SteelCompany. Arcelor Steel Company was using its old technology to make steel while Mittal SteelCompany was using the new technology and as a result, Mittal Steel Company was able to sellsteel at lower price than Arcelor Steel Company due to its low cost of production. Arcelor SteelCompany was approaching corporate failure and luckily, Mittal Steel Company merged withArcelor Steel Company and became ArcelorMittal Steel Company, thus preventing Arcelorfrom failure.Working capital problemsOrganizations also face liquidity problems when they are in financial distress. Poor liquiditybecomes apparent through the changes in the working capital of the organization as they haveinsufficient funds to manage their daily expenses.Businesses, which rely only on one large customer or a few major customers, can face severeproblems and this can be detrimental to the businesses. Losing such a customer can causebig problems and have negative impact on the cash flows of the businesses.Besides, if such a customer becomes bankrupt, the situation can even become worst, as the

firms will not be able to recover these debts.

Economic distressA turndown in an economy can lead to corporate failures across a number of businesses. The level ofactivity will be reduced, thus affecting negatively the performance of firms in several industries. This

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cannot be avoided by businesses.The recent economic crisis in the USA led to many cases of corporate failures. One of them isthe insurance AIG insurance company. It is facing serious problems and it might close its doorin the near future.MISMANAGEMENTInadequate internal management control or lack of managerial skills and experience is thecause of the majority of company failures. Some managers may lack strategic capability thatis to recognize strengths, weaknesses, opportunities and threats of a given businessenvironment. These managers tend to take poor decisions, which may have badconsequences afterwards.Furthermore, managers of different department may not have the ability to work closelytogether. There are dispersed department objectives, each department will work for their ownbenefits not towards the goal of the company. This will bring failure in the company. Oneexample can be WorldCom, where the finance and legal functions were scattered over severalstates and communication between these departments were poor.OVER-EXPANSION AND DIVERSIFICATIONResearch has shown that dominant CEO is driven by the ultimate need to succeed for theirown personal benefits. They neglect the objective set for the company and work for their selfinterest.They want to achieve rapid growth of the company to increase their status and paylevel. They may do so by acquisition and expansion.The situation of over expansion may arise to the point that little focus is given to the corebusiness and this can be harmful as the business may become fragment and unfocused. Inaddition, the companies may not understand the new business field. Enron and WorldComcan be an example for this situation where the managers did not understand how growingovercapacity would influence its investment and therefore did not comprehend the risksassociated with it.FRAUD BY MANAGEMENT

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Management fraud is another factor responsible for corporate collapse. Ambitious managersmay be influenced by personal greed. They manipulate financial statements and accountingreports. Managers are only interested in their pay checks and would make large increase inexecutive pay despite the fact that the company is facing poor financial situation. Dishonestmanagers will attempt to tamper and falsify business records in order to fool shareholdersabout the true financial situation of the company.These fraudulent acts or misconduct could indicate a serious lack of control. These frauds canlead to serious consequences: loss of revenue, damage to credibility of the company,increased in operating expenses and decrease in operational efficiency.POORLY STRUCTURED BOARDBoard of Directors is handpicked by CEO to be docile and they are encouraged by executivepay and generous benefits. These directors often lack the necessary competence and may notcontrol business matters properly. These directors are often intimated by dominant CEO anddo not have any say in decision making. Example Enron and WorldCom where poorlystructured board was a contributor towards their failure.Financial distressFirms that become financially distressed are found to be under- performing relative tothe other companies in their industry. Corporate failure is a process rooted in the managementdefects, resulting in poor decisions, leading to financial deterioration and finally corporatecollapse. Financial distresses include the following reasons also low and declining profitability,investment Appraisal, Research and Development and technical insolvency amongst others.A firm may fail, as its returns are negative or low. A firm that consistently reportsoperating losses probably experiences a decline in market value. If the firm fails to earn areturn greater than its cost of capital, it can be viewed as having failed. Falling profits have anobvious link with both financial and bankruptcy as the firm finds it is not generating enough

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money to meet its obligations as they fall due.Another cause that will lead the company to fail is the investment appraisal. Manyorganizations run into difficulties as they fail to appraise investment projects carefully. Thelong-term nature of many projects means that outcomes are difficult to forecast andprobabilities are usually subjective. “Big project gone wrong” is a common cause of decline.For example, the acquisition of a loser company, this has happen in the case for the failure ofParmalat Co Ltd of Italy, which made the acquisition of several losses making company where

Inappropriate evaluation of the acquired company, its strengths and weaknesses.

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SCOPE OF THE STUDY

Scope of the study was confirmed to internal environment only. The study based on the secondary data collected from annual report, journals, magazines, newspapers, and website etc.

Financial statement analysis is the process of identifying the financial position of the company. After duly recognizing the importance of financial statement analysis of this topic has been chosen as the focus of the project.

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Overview of steel Industry

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THE INDIAN STEEL SECTOR :DEVELOPMENT AND POTENTIALAt the time of independence in 1947, India had only three steel plants - the Tata Iron & Steel Company, the Indian Ironand Steel Company and Visveswaraya Iron & Steel Ltd and a few electric arc furnace-based plants. The period till 1947thus witnessed a small but viable steel industry in the country, which operated with a capacity of about 1 million tonneand was completely in the private sector. From the fledgling one million tonne capacity status at the time of independence,India has now risen to be the 5th largest crude steel producer in the world and the largest producer of sponge iron. Asper official estimates, the Iron and Steel Industry contributes around 2 per cent of the Gross Domestic Product (GDP)and its weight in the Index of Industrial Production (IIP) is 6.2 per cent. From a negligible global presence, the Indiansteel industry is now globally acknowledged for its product quality. As it traversed its long history during the past 61

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years, the Indian steel industry has responded to the challenges of the highs and lows of business cycles. The first majorchange came during the first three Five-Year Plans (1952-1970) when in line with the economic order of the day, theiron and steel industry was earmarked for state control. From the mid-50s to the early 1970s, the Government of Indiaset up large integrated steel plants in the public sector at Bhilai, Durgapur, Rourkela and Bokaro. The policy regimegoverning the industry during these years involved:n Capacity control measures: Licensing of capacity, reservation of large-scale capacity creation for the public sectorunits.n A dual-pricing system: Price and distribution control for the integrated, large-scale producers in both the private andpublic sectors, while the rest of the industry operated in a free market.n Quantitative restrictions and high tariff barriersn Railway freight equalisation policy: To ensure balanced regional industrial growth.n Controls on imports of inputs, including technology, capital goods and mobilisation of finances and exports.The large-scale capacity creation in the public sector during these years contributed to making India the 10th largeststeel producer in the world as crude steel production grew markedly to nearly 15 million tonne in the span of a decadefrom a mere 1 million tonne in1947. But the trend could notbe sustained from the late 1970'sonwards, as the economicslowdown adversely affected thepace of growth of the IndianSteel Industry. However, thisphase was reversed in 1991-92,when the country replaced thecontrol regime by liberalisationand deregulation in the contextof globalisation. The provisionsof the New Economic Policyinitiated in the early 1990'simpacted the Indian steelindustry in the following ways:n Large-scale capacities wereremoved from the list ofindustries reserved for thepublic sector. The licensingrequirement for additionalcapacities was also

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withdrawn subject tolocational restrictions.December 26, 1959: the then President Dr. Rajendra Prasad after inaugurating Blast Furnace # 1 at SAIL’sDurgapur Steel Plant.12n Private sector came to play a prominent role in the overallset-up.n Pricing and distribution control mechanisms werediscontinued.n The iron and steel industry was included in the highpriority list for foreign investment, implying automaticapproval for foreign equity participation up to 50%,subject to the foreign exchange and other stipulationsgoverning such investments in general.n Freight equalisation scheme was replaced by a systemof freight ceiling.n Quantitative import restrictions were largely removed.Export restrictions were withdrawn.The system, thereafter, underwent marked changes. For steelmakers, opening up of the economy opened up newchannels of procuring their inputs at competitive rates fromoverseas markets and also new markets for their products.It also led to greater access to information on globaloperations/techniques in manufacturing. This, along withthe pressures of a competitive global market, increased theneed to enhance efficiency levels so as to becomeinternationally competitive. The steel consumer, on the otherhand, was now able to choose items from an array of goods,be it indigenously manufactured or imported.This freedom to choose established the sovereignty of the consumer and galvanised steel producers to provide products/service levels in tune with the needs of the consumers. With the opening up of the economy in 1992, the countryexperienced rapid growth in steel making capacity. Large integrated steel plants were set up in the Private Sector byEssar Steel, Ispat Industries, Jindal Group etc. Tata Steel also expanded its capacity. To sum up, some of the notablemilestones in the period were:n Emergence of the private sector with the creation of around 9 million tonne of steel capacity based on state-of-thearttechnology.n Reduction/ dismantling of tariff barriers, partial float of the rupee on trade account, access to best-practice of

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global technologies and consequent reduction in costs - all these enhanced the international competitiveness ofIndian steel in the world export market.After 1996-97, with the steady decline in the domestic economy's growth rate, the Indian steel industry's pace of growthslowed down and in terms of all the performance indicators - capacity creation, production, consumption, exports andprice/ profitability - the performance of the industry fell below average. In foreign trade, Indian steel was also subjectedto anti-dumping/ safeguard duties as most developed economies invoked non-tariff barriers. Economic devastationcaused by the Asian financial crisis, slowdown of the global economy and the impact of glut created by additionalsupplies from the newly steel-active countries (the steel-surplus economies of erstwhile USSR) were the factors thatpulled down growth levels.However, from the year 2002, the global industry turned around, helped to a great extent by China, whose spectaculareconomic growth and rapidly-expanding infrastructure led to soaring demand for steel, which its domestic supply couldnot meet. At the same time, recoveries in major markets took place, reflected by increase in production, recovery ofprices, return of profitability, emergence of new markets, lifting of trade barriers and finally, rise in steel demand -globally. The situation was no different for the Indian steel industry, which by now had acquired a degree of maturity,with emphasis on intensive R&D activities, adoption of measures to increase domestic per capita steel consumptionand other market development projects, import substitution measures, thrust on export promotion and exploringglobal avenues to fulfil input requirements.November 27, 1967: Levelling work in progress at the site for SAIL’s BokaroSteel Plant.13

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Z- SCORE ANALYSIS

A company failure or bankruptcy prediction method developed by Professor Edward Altman of New York University. A company's Z score is a positive function of five factors: (net working capital) / (total assets) (retained earnings) / (total assets) (EBIT) / (total assets) (market value of common and preferred) / (book value of debt) (sales) / (total assets).Although the weights are not equal, the higher each ratio, the higher the Z score and the lower the probability of bankruptcy. Also called Zeta.

Quickly form an objective view of your company's financial health.

In what would take hours to develop, in minutes you'll have an indication of a company's

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financial health, trends and know if it is likely to survive and grow.

Originally developed as a bankruptcy predictor for manufacturing companies, it can be applied to public or private manufacturing firms, or private general firms. It has been used widely by investors, banks, stock analysts, accountants and business executives to form an objective view of a business’ financial health; exposing non-standard accounting practices and highlighting focus-areas for improvement.

Contents include, detailed notes from the developer with contact information, graph and 5 formulas to calculate a company’s financial health and trend.

Once you know the financial facts of a business, use the Applied Strategy Execution Guide + Slides to put a strategic plan into action.

Save money and purchase this product as a part of the Business Process Management Power Tools collection.

The Z-score formula for predicting bankruptcy was published in 1968 by Edward I. Altman, who was, at the time, an Assistant Professor of Finance at New York University. The formula may be used to predict the probability that a firm will go into bankruptcy within two years. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies in academic studies. The Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.

Estimation of the formula

The Z-score is a linear combination of four or five common business ratios, weighted by coefficients. The coefficents were estimated by identifying a set of firms which had declared bankruptcy and then collecting a matched sample of firms which had survived, with matching by industry and approximate size (assets).

Altman applied the statistical method of discriminant analysis to a dataset of publicly held manufacturers. The estimation was originally based on data from publicly held manufacturers, but has since been re-estimated based on other datasets for private manufacturing, non-manufacturing and service companies.

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The original data sample consisted of 66 firms, half of which had filed for bankruptcy under Chapter 7. All businesses in the database were manufacturers, and small firms with assets of <$1 million were eliminated.

The original Z-score formula was as follows: Z = 0.012T1 + 0.014T2 + 0.033T3 + 0.006T4 + 0.999T5.

T1 = Working Capital / Total Assets. Measures liquid assets in relation to the size of the company.

T2 = Retained Earnings / Total Assets. Measures profitability that reflects the company's age and earning power.

T3 = Earnings Before Interest and Taxes / Total Assets. Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.

T4 = Market Value of Equity / Book Value of Total Liabilities. Adds market dimension that can show up security price fluctuation as a possible red flag.

T5 = Sales/ Total Assets. Standard measure for sales turnover (varies greatly from industry to industry).

Altman found that the ratio profile for the bankrupt group fell at -0.25 avg, and for the non-bankrupt group at +4.48 avg.

Accuracy and effectiveness

In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event, with a Type II error (false positives) of 6% (Altman, 1968). In a series of subsequent tests covering three different time periods over the next 31 years (up until 1999), the model was found to be approximately 80-90% accurate in predicting bankruptcy one year prior to the event, with a Type II error (classifying the firm as bankrupt when it does not go bankrupt) of approximately 15-20% (Altman, 2000).[1]

From about 1985 onwards, the Z-scores gained wide acceptance by auditors, management accountants, courts, and database systems used for loan evaluation (Eidleman). The formula's approach has been used in a variety of contexts and countries, although it was designed originally for publicly held manufacturing companies with assets of more than $1 million. Later variations by Altman were designed to be applicable to privately held companies (the Altman Z'-Score) and non-manufacturing companies (the Altman Z"-Score).

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Neither the Altman models nor other balance sheet-based models are recommended for use with financial companies. This is because of the opacity of financial companies' balance sheets, and their frequent use of off-balance sheet items. There are market-based formulas used to predict the default of financial firms (such as the Merton Model), but these have limited predictive value because they rely on market data (fluctuations of share and options prices to imply fluctuations in asset values) to predict a market event (default, i.e., the decline in asset values below the value of a firm's liabilities).[2]

[edit] Original Z-score Component Definitions Variable Definition Weighting Factor

T1 = Working Capital / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Market Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

Z Score Bankruptcy Model:

Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5

Zones of Discrimination:

Z > 2.99 -“Safe” Zone

1.8 < Z < 2.99 -“Grey” Zone

Z < 1.80 -“Distress” Zone

[edit] Z-score estimated for private firms

T1 = (Current Assets-Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

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Z' Score Bankruptcy Model:

Z' = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5

Zones of Discrimination:

Z' > 2.9 -“Safe” Zone

1.23 < Z' < 2. 9 -“Grey” Zone

Z' < 1.23 -“Distress” Zone

[edit] Z-score estimated for Non-Manufacturer Industrials & Emerging Market Credits

T1 = (Current Assets-Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

Z-Score Bankruptcy Model:

Z = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

Zones of Discrimination:

Z > 2.6 -“Safe” Zone

1.1 < Z < 2. 6 -“Grey” Zone

Z < 1.1 -“Distress” Zone

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RESEARCH METHODOLOGY

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COLLECTION OF DATA

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DATA PROCESSING

PERIOD OF THE STUDY

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ANALYSIS AND DISCUSSIONS

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LIMITATIONS OF THE STUDY

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1. The analysis of this study is mainly based on secondary data.

2. The financial statements are generally based on historical or original cost. The current economical condition is ignored.

Despite all the research supporting z-score analysis, it is important to realize that evidence regarding its shortcomings also exists. For example, Steven Hall (2002) provides some reasons why the method should be used carefully: 1) when the Altman model was designed, the research was primarily from manufacturing firms and hence, it may not apply to all industries; 2) the bankruptcies studied by Altman were for the period between 1946-1965. As most large firms operate in several industries, matching can be difficult. It is not clear if past experience will always be transferable to future situations given the dynamic environment in which business operates. The model may need to be adjusted so the weights assigned to each ratio can truly reflect today’s financial conditions. Grice and Ingram (2001) also question whether Altman’s model is as useful now as it was when developed. They pondered if the model was as successful with non-manufacturing firms as with manufacturing firms. Finally, the authors set out to determine if the model could predict “financial stress conditions other than bankruptcy”. They concluded that the z-score analysis is not as successful in predicting recent firms as it was in the past. The authors also found that the model was useful for predicting financial distress other than bankruptcy, but mainly for manufacturing firms. Hall (2002) states that the model applies only if the financial statements being reviewed accurately represent the position of the company (i.e. sales have not been inflated, or expenses, liabilities or losses have not been hidden to alternate the profitability of the firm). Grice and Ingram (2001) state that the z-score analysis does not incorporate pre-bankruptcy non-financial events that may result in bankruptcy (i.e. union problems, lawsuits, etc). There is no underlying theory relating to the process by which firms become bankrupt, and therefore more analysis may be needed.

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CONCLUSION

Financial ratio analysis has been used to assess profitability and risk, current and future, from the viewpoint of lenders, investors, and other creditors with the firm. Ratios vary depending on the trading conditions. The economic conditions during the periods covered by the accounts being analyzed is an important consideration. The researchers used Altman Z-scores and ratio analysis approaches to conclude their views why the firm under study went bankrupt. Therefore, we concluded that Altman’s model may be used as an indicator and perhaps evidence to determine the firm’s bankruptcy- in the future. We know that a mathematical model is an abstraction of reality, therefore, we believe that further evidence and economic indicators may be needed to determine outcome of the firm’s future operating activities and its financial position performance. Ratios indicated the firm is being run by using assets to generate sales and is ineffective it is in controlling costs, producing profits based on goods and services sold.

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The level of liquidity puts the firm in difficult economic circumstances. Investor ratios which measure how the price of a share in the stock market compares to key financial markets performance indicators is not encouraging. The dividend yield has fallen and all shares have fallen in price over the years studied.

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RECOMMENDATIONS

We recommend that the following steps to be taken to strengthen the firm and improve the market value of its stock and perhaps avoid the bankruptcy if it is possible.

1) Use the decentralization concept in the decision making process, which gives the employees the initiative and responsibility to adapt their behavior and decisions according to changes in the working environment.

2) Confirm that the firm should use consistent accounting policies over time enhancing the cost accounting and information systems if a significant change has taken place.

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3) Look carefully at increasing prices or attempting to control costs of goods sold more effectively.

4) Reschedule the debts and increase the liquidity in the future within acceptable ranges. . The firm’s total debts (5 M JD), represent 17% of the firm’s capital.

5) Since liquidity has fallen within an unacceptable range, depend on short-term loans and shorten the period of credit extended to customers, this should be investigated as a matter of urgency.

6) Manage the inventory on a productive capacity (e.g. control raw materials movement by using a just -in -time inventory system). Also control the movement of stock; the quicker the goods move, the better.

7) Reduce in expenses to meet obligations as they fall due, by timing cash inflows and cash outflows. Operate on a lower current ratio and avoid building up cash flow problems.

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