Prediction of Corporate Failure in Nepal

Abstract

This study has examined the usefulness of seventeen financial ratios in discrimination of failed companies and non-failed companies. Out of them, the ratios of current assets to total assets, current liabilities to total debt, shareholder's equity to total debts, current assets to net sales, net sales to total assets, net sales capital employed, earnings before interest and tax to total assets, net income to net sales, net income to total assets, cash flow to net sales and cash flow to current liabilities are statistically significant between failed companies and non-failed companies. It also concludes that failed companies use more debts. Liquidity, profitability, cash flow, and turnover ratios of failed companies are poorer than non-failed companies. Using multivariate discriminant analysis (MDA) as a technique of data analysis, it is concluded that MDA can classify failed and non-failed companies with 87.5% classification accuracy in one and three year, 91% accuracy in two year and 79% in four year prior to failure of a company. Only four financial ratios: current liabilities to total debts; net sales to total assets, earnings before interest and tax to interest and cash flow to earnings before interest and tax have been found statistically significant in multivariate discriminant model for predicting failed companies and non-failed companies. On the basis of standard coefficient, the ratio of current liabilities to total debts is found the most important ratio in discrimination of failed and non-failed companies followed by earnings before interest and tax to interest, net sales to total assets, and cash flow to earnings before interest and tax respectively.