Abstract
The overall objective of this research is to analyze the financial condition of failing companies prior to bankruptcy, in comparison with non-failing companies, which are matched on the industry, size, and time-period. The sample consists of 168 SMEs from the wholesale and retail industry, whose financial statements were analyzed for the 2011-2015 period. The analysis is primarily based on the ratio analysis and the models developed for bankruptcy prediction and financial statement manipulation. Mann-Whitney U test is used to compare differences between failing and non-failing SMEs for a set of twenty variables. Research findings indicate that there is a significant difference between failing and non-failing SMEs, especially in accruals, asset quality, leverage, profitability, and liquidity. For the very first time in the transition economy of CEE Bosnia and Herzegovina, the pre-bankruptcy behavior of failing SMEs is analyzed, providing insights into potentially manipulated areas, which represent the main contribution of the research.
Highlights
The challenges of transition economies, lack of transparency and monitoring, and high tax burdens represent an unfavorable business environment, especially for small and mediumsized enterprises
The Z-score model was applied to the financial statements of failing and non-failing companies for each year in the period 2011-2015
At the same time, aligned with financial distress, red flags that point to the increased likelihood of earnings manipulation become evident through deteriorating gross margins, higher leverage, higher positive accruals, and engagement in cost deferral
Summary
The challenges of transition economies, lack of transparency and monitoring, and high tax burdens represent an unfavorable business environment, especially for small and mediumsized enterprises. In such circumstances, companies may resort to undesirable financial reporting practices. When faced with financial turmoil, companies are inclined to employ some creative accounting practices to improve their financial performance, primarily due to the company’s stakeholders (suppliers, investors, banks, employees, etc.). Especially small and mediumsized, are heavily dependent on bank loans, which puts additional pressure on the company’s management to falsify the financial reports.
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