Financial statement analysis

Presentation by Ashalakshmi RK

Analysis of corporate failure

Severe financial crisis leading to technical real insolvency or bankruptcy Models : 1.Univariate models A. Dichotomous test B. Unitary test

2.Multivariate models A.Altmans MDA B.Mayer and Pifers linear regression analysis C.Westerfields residual analysis D. Zavgrams logit probability analysis

Univariate analysis
Specific aspects of financial positions are analysed Aggregate impacts are not considered Individual variable =individual accounting ratio Assumptions-1.Difference exists between strong &distressed 2.Used for predicting corporate failure

Techniques of univariate analysis

A.DICHOTOMOUS Test: Failed &non-failed enterprises Usage of sensitive accounting ratios Identifying the main sources of failures Firms in between are not considered

W.H.Beavers contribution
Concentrated on empirical research findings 1.Sample selectionFirms asset size Trend of industrial environment 79 failed firms &79 non-failed firms 5years data prior to insolvency

 2.Selection of failure of sensitive ratios Testing propositions through 30 accounting ratios Reservoir of liquid assets Solvency in terms of reservoir will be exhausted Larger reservoir, smaller probability of insolvency

 Greater net asset inflow smaller the probability Larger outstanding debt ,higher insolvency Greater asset outflow, higher insolvency Cash flow ratios(4),NI ratios (4), D/TA ratios(4), LA/TA ratios(4), LA/current debt ratios(3), Turnover ratios(8), defensive interval ratios(3)

B.Unitary test
Enterprise is evaluated separately One variable is not compared with industry average Enterprise is considered as a unit Stage 1-tending towards sickness Stage2 incipient sickness Stage3-sick Stage 4-total sickness or business closure

Multivariate analysis
Several variables are used simultaneously for prediction A. Altmans multiple discriminant analysis: Edward Altman One index, named Z score was computed by combining major financial ratios Technique MAD Multiple variables are combined togethercategorized in two groups

 Discriminating bankrupt and non bankrupt firms Steps to MDA: Priori classification of objects Data on various economic characteristics Linear combination of features Data collected from normal population Variance ,co-variance matrices are same

Equation Converts value of variables into z score Z score is used to identify failed or non-failed 33 pairs are used 22 accounting &non-accounting firms Liquidity ,profitability , financial leverage, solvency ,activity

Coefficient regression analysis Discriminant function? Z score cutoff points 0 to 1.81 to 2.99

 2.Meyer and Pifers model/linear regression analysis: Regression equation for failures Financial ratios are independent variables Banks dependent /dummy variables Failed banks 0 , non failed 1 Total 39 paired failed &non-failed 32 financial measures

3.Westerfields Residual analysis: Market price movements of 20 bankrupt firms Technique share price analysis Movements Factors common to all firms in the industry Factors that affect only the individual firm

 4.Logit probability analysis: C V Zavgren Accounting ratios drawn from pairs of failed and non-failed firms of same size & same industry Large set of financial ratios Reduced to subset Coefficients of each accounting variables are specified Equation ?

Accounting issues in FSA-IFRS

IFRS-International Financial Reporting Standard ICAI-Institute of Chat