Saturday, January 10, 2009

BANKRUPTCY PREDICTION. What are indicators of financial distress? What are indicators used in predicting corporate bankruptcy?


Here are some concise points for our Financial Learning Corner.

Will the company fail?
Some key indicators you can use in predicting corporate bankruptcy are:
 Cash flow from operations to total liabilities
 Net income to total assets
 Total liabilities to total assets
 Quick ratio
 Current ratio
 Operating income to total assets
 Interest coverage (income before interest and Taxes o interest)
 Retained earnings to total assets
 Common equity to total liabilities
 Working capital to total assets
 Debt to equity
 Fixed assets to stockholders' equity

Does company size bear a relationship to the probability of failure?
In a study done by Dun & Bradstreet, it was found that small companies had higher failure rates than large companies. Size can be measured by total assets, sales, and age.

What are indicators of financial distress?
Financial and operating deficiencies pointing to financial distress include:
 Significant decline in stock price
 Reduction in dividend payments
 Sharp increase in the cost of capital
 Inability to obtain further financing
 Inability to meet past—due obligations
 Poor financial reporting system
 Movement into business areas unrelated to the company's basic business
 Failure to keep up—to—date
 Failure to control costs
 High degree of competition

A negative net assets (fund balance) (total liabilities exceed total assets) indicates a worrisome deficit position that is an indicator of potential bankruptcy. Cash forecasts showing expected cash outflows exceed expected cash inflows may point to financial distress. If cash is a problem, timely steps may be needed to improve cash flow and solve problems. How long will the current cash position last if all cash inflows were to cease?

A balanced budget, using conservative revenue estimates, is its own way to avoid financial ruin. A balanced budget requires difficult choices, such as curtailment or elimination in certain services or programs.

Answer these questions to gauge the probability of potential failure:
 Is there adequate insurance?
 Does excessive legal exposure exist? What is the nature of pending lawsuits?
 What government adjustments are expected regarding rate charges and reimbursements?
 Is there inadequate control over expenditures?
 Is there deferred maintenance that can no longer be postponed?
 Are loan restrictions excessive?
 What effect will contractual violations have?
 Are costs skyrocketing? Why?
 Are bills past due?
 Is debt excessive?
 Are debt repayment schedules staggered?
 Are more grant applications being rejected?
 Is there a cash shortage?
 Is there a buildup in assets (e.g., receivables)?
 Is a hedging approach used to finance assets by matching against them the maturity dates of liabilities?
 Is there a sharp increase in the number of employees per unit of service?
 Are there open lines of credit?
 Does a lack of communication exist?

Ways to avoid financial problems include:
 Merging with another financially stronger similar company. Will a merger aid in financing, lower overall operating costs, synergy and efficiency, and program expansion?
 Restructuring the organization.
 Selling off unproductive assets.
 Deferring the payment of bills.
 Discarding programs and activities no longer financially viable.
 Implementing a cost reduction program, including layoffs and attrition. But will this eliminate programs that will be hard to start up again? Are we getting rid of scarce talent? Such cuts are referred to as irreversible reductions, which in the long run may not be wise.
 Increasing service fees.
 Increasing fundraising efforts and contributions.
 Applying for grants.
 Stimulating contracts.

For more Information:
Bankruptcy and Debt Management
Distressed Debt Analysis, Debt Management, Financial Distress and Restructuring Process, How to Profit from Financial Distress



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