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The document discusses the importance of monitoring financial health and risk management in organizations due to global economic uncertainties. It highlights the use of the Altman Z-Score model as a reliable tool for predicting bankruptcy and assessing financial stability, emphasizing its continued relevance in various industries. The analysis of financial ratios and models like Z-Score and X-Score are crucial for companies to evaluate their solvency and make informed management decisions.

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7 views

Task 3

The document discusses the importance of monitoring financial health and risk management in organizations due to global economic uncertainties. It highlights the use of the Altman Z-Score model as a reliable tool for predicting bankruptcy and assessing financial stability, emphasizing its continued relevance in various industries. The analysis of financial ratios and models like Z-Score and X-Score are crucial for companies to evaluate their solvency and make informed management decisions.

Uploaded by

leiam.kamarie
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Task 3

Introduction:
It is fundamental that the management of the organization monitors the financial
health and the level of risk of the company considering the high degree of
uncertainty and competitiveness at the global scale. The financial solidity of a
company is determined by its capability to make timely payments, adequately
finance its operation and face contingencies. Regardless of their size and economic
activity, companies should overcome various challenges when pursuing their
corporate purpose to guarantee their permanence in the market. Some of these
challenges include the deceleration of economic activity, which may lead to a
decrease in sales and, thus, to loss of liquidity and also to an increase of the risk of
financial difficulties. One of the options for monitoring the situation previously
described, is to analyze the probabilities of financial bankruptcy in the short and
medium term.
Ratio analysis is an analysis that is often used in assessing the company's financial
performance, but the ratio analysis showing only one aspect without being able to
associate with other aspects. Each ratio has a usability and provide an indication of
the different information regarding the company's financial health, the ratio
sometimes conflicting with each other. To complete the lack of analysis of the ratio
of researchers used an analysis tool that can connect multiple ratios at once,
namely Z-score analysis. Corporate bankruptcy is a sensitive issue in the financial
world, since it refers to the financial health and stability of the organizations. The
capability for predicting financial insolvency of a company is fundamental for its
development and sustainability. However, the inability to precisely predict the risk
of bankruptcy may produce devastating socioeconomical effects.
The Z-Score model has become a prototype for many of these internal-rate based
models. Asset manager investors need to have reliable tools for the selection of
companies into their portfolios. Financial ratios are primarily used to evaluate the
operational coherence of an organization, even when it operates in challenging
conditions or faces the risk of liquidation. One notable method for assessing an
entity's potential for liquidation is the Altman Z-Score. This method is recognized
for its reliability and effectiveness as a diagnostic tool, irrespective of the
organization's size. Importantly, even if a company appears to be thriving, a low Z-
Score signals potential financial distress and necessitates caution. Similarly,
organizations with strong financial performance must remain vigilant, as the risk of
liquidation can still pose a significant threat.
Over the past century, a lot has changed in the assessment of financial stability or
bankruptcy prediction. The first widely accepted bankruptcy prediction model was
established by Edward Altman in 1968. Before that, companies used to hire
external agencies to perform qualitative analysis on clients. Later, studies were
established using a variety of ratio measurements because one thing was clear back
then: financially distressed companies have different financial ratios than healthy
companies. Bankruptcy is a very important phenomenon related to compromises in
financial performance and company activities. A company is declared bankrupt if
its total liabilities exceed its total assets. Company’s financial condition can be
used as a measurement of its ability to maintain its operations. Thus, companies
need to analyze and evaluate their financial statements. Financial analyses are
conducted through the calculation of ratios, so the financial condition of companies
in the past, present, and future can be assessed. Many analytical methods can be
used to predict bankruptcy.
In spite of the vast research on failure prediction, the original Z-Score Model
introduced by Altman (1968) has been the dominant model applied all over the
world. Thus, although the Z-Score Model has been in existence for more than 45
years, it is still used as a main or supporting tool for bankruptcy or financial
distress prediction or analysis, both in research and practice. Our study is focused
on this classic model. The analyses that can be used to predict bankruptcy are
Altman (Z-Score) model and Zmijewski (X-Score) model. Both models use
financial statements, but the ratios they use are different, and so are the results.
These results can be used as a consideration for the management, in this case, by
considering the similar results of the two. The approach used for bankruptcy
prediction has been evolving over time. Beaver (1966, 1968) used univariate
analysis for selected ratios and detected that some of them had a very good
predictive power. Altman (1968) moved significantly forward since he developed a
multiple discriminant analysis model (MDA) called the Z-Score Model with 5
ratios.
Altman’s original bankruptcy model is widely used nowadays. It is being used in a
variety of industries to evaluate financial conditions. The model is also being used
in multiple business situations where there is need for the assessment of financial
stability. In this case, this research defines financial stability as a company's ability
to stay solvent. Moreover, the model issued by commercial banks who use it as a
part of their periodic loan review process while investment bankers apply the
model to support security and portfolio analysis. The model has also been used as a
decision tool for managers and as a part of auditors 'assessment of their clients’
abilities to remain solvent. Additionally, the assessment of credit risk is
increasingly important given the requirements of Basle II and explosive credit
growth.

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