Bankruptcy Prediction Model

Question: Discuss about the Bankruptcy Prediction Model. Answer: Bankruptcy Prediction model is used to determine as to whether any firm is a going concern or not. Under this model predictions are made on various measures of financial distress of a firm. It includes the wide areas of accounting and finance. These predictions play a vital role. This model is considered as most reliable model by the investors and creditors for considering a firm as going concern. Thus, importance of this model has been increased in recent years due to increased financial crisis in the whole world. Major objective of this study is to check the reliability of different prediction theories used to check the solvency power of the firm. It uses the technical penal data for estimating the probability of financial difficulties. This model use the data form G-7 countries in order to obtain a marker of various financial issues that includes the specific nature of every firm. Following Calculation is used under this model- This model is based upon the logit model for predicting various financial variables relating to bankruptcy. This study use the various models to predict the variables, sometimes it become difficult to evaluate the best method prediction. So the common method use in G-7 countries is given below- Z Score = [{3.3 * (EBIT/ Total Assets)} + {1.2* (Net Working Capital / Total Assets)} + {1 * (Sales / Total Assets)} + {0.6 * (Market Value of Equity / Book Value of Debt)} + {1.4 * (Accumulated Retained Earnings / Total Assets)}] This formula is used to evaluate the possibility of the firm to be a going concern entity. While making the calculations, if the result of Z score is less than 2.67 then this indicates chances of firm becoming bankrupt more than 95 % within a year. So the going concern is assumed to be in trouble and auditor is required to qualify his audit report regarding the same. Generally three variables are mostly used under this model- Total Earnings / Total Assets Retained Earnings / Total Assets Total Debt / Total Assets The here above mentioned theory gives the best result of bankruptcy as they relate to profitability and debt of any firm. Conclusion This model is globally used by different countries due to increase in the number of bankruptcies in business. This theory is proved to be reliable as the results of this theory confirms the superiority of global model of bankruptcy as compared to regional models. This theory fulfills the requirement of International Auditing Standards and the principle of going concern. It is the feasible model for evaluating the going concern and to support the auditors opinion regarding going concern. This model has some limitations too as this model barely exist. It covers the firms having financial difficulties but fails to focus on bankrupt firms. This model may provide significantly inappropriate results if it is applied for the time period or the industries other than those which were used to develop the model. Hence, the researchers should be cautious in application of this model. References Alaminos, David, Agustn del Castillo, and Manuel ngel Fernndez. "A Global Model For Bankruptcy Prediction". N.p., 2017. Print. Kuruppu, Nirosh, Fawzi Laswad, and Peter Oyelere. "The Efficacy Of Liquidation And Bankruptcy Prediction Models For Assessing Going Concern".Managerial Auditing Journal6/7 (2003): 577-590. Web.