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Advanced Performance Management

M.Com, Batch-2
Shahd Latif (Lecturer, UMT, Sialkot)

Corporate Failure
Corporate failure occurs when a company cannot achieve a satisfactory
return on capital over the longerterm.

The company may still have an excess of assets over liabilities, but if it is unable to convert
those assets into cash it will be insolvent.

For notforprofit organisations, the issue is usually one of funding, and failure is indicated by
the inability to raise sufficient funds to carry out activities effectively.

Although stated in financial terms, the reasons behind such failure are rarely financial, but
seem to have more to do with a firms ability to adapt to changes in its environment. To
assess the risk of corporate failure will thus involve an analysis of both financial and
nonfinancial factors.

Assessing the likelihood of failure

There are a number of ways in which an assessment can be made of how likely a company
is to fail, some using quantitative and some qualitative information:

analysis of the company accounts to identify problems relating to key ratios such as
liquidity, debt cover and profitability

other information in the published accounts, such as:

very large increases in intangible fixed assets

a worsening cash and cash equivalents position shown by the cash flow statement

information in the chairman's report and the directors' report (including warnings, evasions,
changes in the composition of the board since last year)

information in the press (about the industry and the company or its competitors)

The development of corporate failure prediction models

There have been many attempts to develop models to predict the likelihood of corporate
failure. Some of these have been qualitative, and some quantitative.

Advanced Performance Management
M.Com, Batch-2
Shahd Latif (Lecturer, UMT, Sialkot)

Most quantitative models have been based on the analysis of key financial ratios, which
have been weighted and combined to give an overall score. The best known example of this
is the Z score.

Other models have attempted to use qualitative information, by assigning scores to
particular qualitative risk factors.

Quantitative models

A large amount of research has been carried out to try to develop and refine models using
quantitative information.

Models have incorporated trend analysis.
Research has also attempted to take account of variations by industry.
Other models have included a range of different variables, such as:
macroeconomic variables
the quality of management of the company
the growth phase of the firm
the quality of the companys assets.

Qualitative models

Most qualitative methods are based on the use of scoring systems to weight factors which
have been seen to be important in cases of corporate failure.

Some models make extensive use of information technology and systems such as neural
networks and expert systems which model human learning and decision making processes.