Exam 3 - Chapter 8 - Predictive Analytics Flashcards
Define predictive analytics:
Analytics performed to provide foresight by identifying patterns in historical data to judge likelihood of future events.
What is the main difference between:
- descriptive and diagnostic analytics
and
- predictive and prescriptive analytics
Descriptive and diagnostic
Generally report known facts
Predictive and prescriptive
Provide more probabilistic model
What are the three groups of predictive analytics?
- Classification
- Regression
- Time series analysis
Define classification of predictive analytics?
What differentiates classification from regression?
Analytics technique used to separate or classify a sample into two or more groups.
- The output (y-variable) of classification is categorical
- The output variable for regression is numerical
What are a few accounting based questions that classification can answer?
- Bankruptcy classification
- Loan extension classification
- Fraud/no fraud
- Going concern/no going concern
What is a technique used in bankruptcy classification of predictive ananlytics?
Altman’s Z:
Categorizes businesses into classes that determine the risk of bankruptcy based on five business ratios
What are the five business ratios used in Altman’s Z test?
What do these ratios measure?
Working Capital/Total assets
Retained earnings/total assets
Earnings before interest and taxes/total assets
FV of SH equity/ BV total debt owed
Sales / Total assets
The equation for altman’s bankruptcy analysis is:
Z = 1.2x1 + 1.4 x2 + 3.3 x3 + 0.6x4 + 1.0x5
If Z < 1.8 : significant risk of bankruptcy
If Z > 3.0 : no risk of bankruptcy
How does loan extension fall under classification of predictive analytics?
Uses independent variables to classify loan acceptance or loan rejection of customers
- Credit history
- Income
- Loan amount
- Employment length
- Debt-to-income ration
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What factors increase the risk of fraud classification when classifying a company for fraud/no fraud?
- Increase in receivables from prior period
- Decline in gross margin
- Decline in asset quality index (more LT assets)
- Increase in sales growth
- Decrease in depreciation expense
- Decrease in SG&A expenses
- Increase in debt
- Higher total accruals to total assets (more profit on account)
What is regression analysis for predictive analytics?
Method of determining relationship between two sets of variables when one variable is dependent on another independent variable.
How can regression analysis be used for predictive analytics?
- How are firms costs dependent on level of production?
- What are the cost drivers for overhead costs?
- What dependent variables do lendors use to set interest rates?
- What is relationship between investment risk and returns
What are base rates and how do they impact predictions?
Base Rates
Probability of an event occuring based on historical average
- Base rates can be used to gauge reasonableness of predictions
What is a base rate fallacy?
Base rate fallacy
Prediction places too little weight on base rates and uses different information to base prediction
What is time series analysis?
What is persistence in time series analysis?
Time series analysis
Technique used to predit future values based on trends of past values of the same variable
Persistence: Continuity and stability of financial statement variables (will trends continue)?
Dechow and Schrand (2004) looked at the persistence of various financial statement variables over the 1987–2002 time period.
What do these figures indicate?
- Generally high levels of persistence indicate that prior year variables are reasonable predictors
- Operating income’s persistence > Cash flows from operating activities: accrual accounting provides more consistent information than cash
