Predictions of failure and financial distress: A study on Portuguese high and medium-high technology small and mid-sized enterprises

Yehui Tong,Zélia Serrasqueiro

doi:10.14254/2071-8330.2021/14-2/1

Abstract

Predictions of failure and financial distress: A study on Portuguese high and medium-high technology small and mid-sized enterprises

Highlights

Predicting future development and detecting possible failure are of great importance to firms in the dynamic economic environment, because improving the capacity to identify the risk of future financial distress could help businesses adjust their strategy and behavior to avoid financial distress and future bankruptcy, and could mitigate the costs of financial distress and business failure (Gepp & Kumar, 2015; Kubíčková & Nulíček, 2016)
The findings show that: (1) there are more statistically significant variables as indicators to predict business failure than to predict financial distress, so the differences between financially healthy firms and failed firms tend to be more manifest than the differences between financially healthy firms and financially distressed firms; (2) the classification accuracy of failure prediction is obviously higher than that of financial distress prediction, illustrating higher predictability of financial factors on business failure compared to on financial distress; (3) with time prolonging, the classification accuracy of failure prediction decreases obviously while that of financial distress prediction generally keeps stable at a relatively lower level, which demonstrates higher stability in financial prediction of financial distress
With regard to the detailed predictability of financial factors, profitability is the most important indicator on the probability of both business failure and financial distress because of being statistically significant in all the regressions and due to showing significance less than 0.01; and good profitability can help firms avoid business failure and financial distress

Summary

Introduction

Predicting future development and detecting possible failure are of great importance to firms in the dynamic economic environment, because improving the capacity to identify the risk of future financial distress could help businesses adjust their strategy and behavior to avoid financial distress and future bankruptcy, and could mitigate the costs of financial distress and business failure (Gepp & Kumar, 2015; Kubíčková & Nulíček, 2016). The global financial crisis and economic recession since 2008 have made firms’ short-run illiquidity and long-run distress as well as failure become pressing problems (Pervan et al, 2018). This topic is widely and deeply studied by academia, business practitioners and managers (Apergis et al, 2019). Financial distress means financial problems but not in bankruptcy; at the same time, financial distress may result in bankruptcy (Achim et al, 2016; Pozzoli & Paolone, 2016) Putting it another way, failing in part of financial obligations does not necessarily lead to a bankruptcy (Muñoz-Izquierdo et al, 2020); more precisely, financial distress represents potential probability of a bankruptcy (Omelka et al, 2013). As for the financially distressed firms, for resolving distress, their solutions include (for instance) restructuring debts and renegotiating with creditors, selling part of their assets to repay debts, or investing in new profitable projects (Gupta et al, 2018b)

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Results

Discussion

Conclusion