Corporate Failure Flashcards
Argenti - Mistakes
What is meant by “high gearing”?
One mistake a poorly run company makes is to take on too much debt finance.
The gearing is completely unsustainable and is likely to lead to serious problems within the period which the debt is due
Argenti - Mistakes
What is meant by “overtrading”?
The company is growing faster than it can sustain; most of the growth has been financed by loans rather than self generated funds or even by the issue of equity.
Argenti - Mistakes
What is meant by “failure of a big project”?
Becoming involved in a significant project, the failure of which could bring about the downfall of the company.
E.g. cost cutting exercise - cheaper lower quality goods, may be the final error which causes the company to collapse
Argenti - Mistakes
What are the 3 significant ‘business mistakes’ that could lead to symptoms of corporate failure
- high gearing
- overtrading
- failure of a big project
What is the critical Z score which indicates financial crisis?
Anything below 1.8 is considered a risk
What is the Argenti model of corporate failure?
Qualitative and non-accounting factors which lead to corporate failure:
Defects, mistakes & symptoms of failure
What is a quantitative model for predicting corporate failure?
Altman Z-score
Uses publicly available financial information about a firm to predict whether it is likely to fail within the two-year period
Uses an equation where financial data is input and a score is obtained
A score of below 1.8 is a danger level
What is a qualitative model for predicting corporate failure?
Argenti’s
Relies on subjective scores to certain questions given by an investigator
A score above a certain level indicates potential disaster
What are the implications of using the Z-score?
Only gives guidance below danger level of 1.8, large grey area which no clear prediction can be made
The prediction of failure is only probable, not a guarantee
Based on statistical analysis of historic patterns of companies which may not be relevant - unless in same industry and economic circumstances
Open to manipulation through creative accounting
What are the advantages of using Argenti’s model?
The ability to use non-financial aswell as financial measures
Can use judgement of investigator too
What are the disadvantages of using Argenti’s model?
There is a danger that the investigator will give scores to ensure the conclusion agrees with first impressions
What is considered “safe” level of Z-score?
Score of 3 or more
How is market capitalisation calculated?
Share price x no. of shares
How is working capital calculated?
Current assets MINUS current liabilities
How is gearing calculated?
Long-term debt/ Equity
