European Financial and Accounting Journal
European Financial and Accounting Journal
European Financial and Accounting Journal
Faculty of Finance and Accounting, University of Economics, Prague

European Financial and Accounting Journal 2016/3

Empirical Safety Thresholds for Liquidity and Indebtedness Ratios on the Polish Capital Market

DOI: https://doi.org/10.18267/j.efaj.161

[full text (PDF)]

Jacek WELC

One of the elements of company’s evaluation is ratio analysis. It includes computation of bankruptcy risk metrics. There are multiple such measures, of which two seem to be quite universal and commonly applied. These are current ratio and indebtedness ratio. In this study, the accuracy of bankruptcy predictions based on these two ratios is evaluated within a sample of data from the Polish market. Also, the safety thresholds (meant as values at which the probability of bankruptcy exceeds fifty percent) are estimated. The study is based on a sample of 84 companies, in which case a bankruptcy filing was announced in a period between the beginning of 2009 and the end of the first half of 2015. This sample of bankrupt firms is compared to the counter-sample of companies in which case no any bankruptcy filing occurred. The statistical analysis has confirmed the usefulness of both ratios. Even though the sample covers wide variety of businesses, the logit models with only one ratio used as an explanatory variable are capable of identifying bankrupt firms in about 70-73% of cases. Our research has also shown that the estimated safety thresholds lie near the typically assumed “rules of thumb”.

Keywords: Bankruptcy prediction, Current ratio, Financial liquidity, Fundamental analysis, Indebtedness ratio, Ratio analysis

JEL Classification: G32, G33

References:

Atrill, P., 2000. Financial Management for Non-Specialists. Harlow, Pearson Education Limited.

Beaver, W. H., McNichols, M., Rhie, J. W., 2005. Have Financial Statements Become Less Informative? Evidence From the Ability of Financial Ratios to Predict Bankruptcy. Review of Accounting Studies 1, 93-122. DOI: 10.1007/s11142-004-6341-9.

Caouette, J. B., Altman, E. I., Narayanan, P., Nimmo, R. W. J., 2008. Managing Credit Risk. The Great Challenge for Global Financial Markets. Hoboken, John Wiley & Sons. DOI: 10.1002/9781118266236.

Charalambous, C., Charitou, A., Kaourou, F., 2000. Comparative Analysis of Artificial Neural Network Models: Application in Bankruptcy Prediction. Annals of Operations Research 1, 403-425. DOI: 10.2139/ssrn.251082.

Chava, S., Jarrow, R. A., 2004. Bankruptcy Prediction with Industry Effects. Review of Finance 8, 537-569. DOI: 10.1007/s10679-004-6279-6.

David, F. R., 2011. Strategic Management. Concepts and Cases. Upper Saddle River, Prentice Hall.

Demerjian, P. R. W., 2007. Financial Ratios and Credit Risk: The Selection of Financial Ratio Covenants in Debt Contracts. AAA 2007 Financial Accounting and Reporting Section (FARS) Meeting Paper. DOI: 10.2139/ssrn.929907.

Fridson, M., Alvarez, F., 2002. Financial Statement Analysis. A Practitioner’s Guide. New York, John Wiley & Sons.

Giroux, G., 2004. Detecting Earnings Management. Hoboken, John Wiley & Sons.

Graham, B., Dodd, D., 1934. Security Analysis. New York, McGraw-Hill.

Ketz, J. E., 2004. Hidden Financial Risk. Understanding Off-Balance Sheet Accounting. Hoboken, John Wiley & Sons.

Kraft, T., 2015. Rating Agency Adjustments to GAAP Financial Statements and Their Effect on Ratings and Credit Spreads. The Accounting Review 2, 641-674. DOI: 10.2308/accr-50858.

Mackenzie, B., Coetsee, D., Njikizana, T., Chamboko, R., Colywas, B., Hanekom, B., 2012. Interpretation and Application of International Financial Reporting Standards. Hoboken, John Wiley & Sons.

Montier, J., 2009. Value Investing. Tools and Techniques for Intelligent Investment. Chichester, John Wiley & Sons. DOI: 10.1002/9781119209195.

Moyer, R.C., McGuigan, J.R., Kretlow, W.J., 1995. Contemporary Financial Management. West Publishing Company, St. Paul.

Ohlson, J. A., 1980. Financial Ratios and the Probabilistic Prediction of Bankruptcy. Journal of Accounting Research 1, 109-131. DOI: 10.2307/2490395.

Palepu, K. G., Healy, P. M., Bernard, V. L., 2004. Business Analysis & Valuation Using Financial Statements. Mason, Thomson South-Western.

Pratt, S.P., Niculita, A.V., 2008. Valuing a Business. The Analysis and Appraisal of Closely Held Companies. New York, McGraw-Hill.

Revsine, L., Collins, D.W., Johnson, W.B., 2002. Financial Reporting & Analysis. Prentice Hall, Upper Saddle River.

Robinson, T. R., Henry, E., Pirie, W. L., Broihahn, M. A., 2012. International Financial Statement Analysis. Hoboken, John Wiley & Sons.

Saliers, E. A., 1924. Accountant’s Handbook. New York, The Ronald Press Company. DOI: 10.1002/ncr.4110130611.

Shumway, T., 2001. Forecasting Bankruptcy More Accurately: A Simple Hazard Model. Journal of Business 1, 101-124. DOI: 10.1086/209665.

Stickney, C. P., Brown, P. R., Wahlen, J. M., 2004. Financial Reporting and Statement Analysis. A Strategic Perspective. Mason, Thomson South-Western.

Verninmen, P., Quiry, P., Dallocchio, M., Le Fur, Y., Salvi, A., 2005. Corporate Finance Theory and Practice. Chichester, John Wiley & Sons.

Wheelen, T. L., Hunger, J. D., 1995. Strategic Management and Business Policy. New York, Addison Wesley.

White, C., 2004. Strategic Management. New York, Palgrave Macmillan.

White, G. I., Sondhi, A. C., Fried, D., 2003. The Analysis and Use of Financial Statements. Hoboken, John Wiley & Sons.

Zmijewski, M. E., 1984. Methodological Issues Related to the Estimation of Financial Distress Prediction Models. Journal of Accounting Research 2, 59-82. DOI: 10.2307/2490859.