Part 3 - Business failure Flashcards
Business failure
- Z-scores is a quantitative model based around a number of financial indicators
- Argenti’s A-score model is a qualitative model which assesses defects, mistakes and symptoms of decline within an organisation.
The appropriateness of Z-scores
- Financial ratios which significantly differ in value between surviving and failing companies.
- The weightings for these ratios in a formula for a score which can be used to identify companies which exhibit the features of previously failing companies
Inappropriateness of Z-scores: Z-score was originally developed in the late 1960s and was based on data from US companies
- The world economy has changed significantly since Altman’s original work. The data for this model is now nearly 50 years old.
- The economy of the USA may not reflect the market in which Culam works.
- The mining sector is not like general manufacturing, for example, it is highly capital intensive with long periods of no revenue generation.
The Q-score model was based on recent data from Teeland businesses
- The Q-score is based on data for Teeland listed companies and Culam is a mining company with an unusual pattern of revenue and costs supplying a global market => unsimilar
- If Teeland’s exchange is small, there may not be much data from failing companies on which to base the model.
The usefulness of the quantitative K Score model
Ad:
- Calculated easily from readily available financial data
- No subjectivity required in calculating the score which can be easily compared
Dis:
- Uses historical data
- Data may be unavailable or unreliable
- K Scores of between 2 and 5 lie in the ‘grey area’, where further analysis is needed in order to reach a clear conclusion.
- it does not give any suggestions on how to reduce the likelihood of corporate failure.
Operational gearing
Operational gearing indicates the level of business risk which companies face by measuring the relative amount of fixed costs.
Financial gearing
The financial gearing ratio measures financial risk and reflects the company’s ability to service its long-term debt.
What is A-Score
The Argenti A Score assigns scores to management defects and accounting defects, which are effectively weaknesses which can lead to failure, mistakes, and symptoms.
Advantages of using qualitative models
- The subjectivity of the A Score => allows the person calculating the A Score to use their own professional judgement in considering individual circumstances.
- It also recognises factors which have been observed in failing companies
- The A Score model incorporates financial (such as the operating gearing ratio), and non-financial factors, which give a more holistic assessment
Disadvantages of using qualitative models in predicting corporate failure
- Calculating the A Score is subjective and requires experience and professional judgement,=> difficult to compare the score between organisations.
- The A Score focuses on internal factors, which limits its usefulness.
- A limitation of the A Score model is that it is only a snapshot at a particular time and does not indicate when corporate failure may occur.
- The fact that the A Score does not give a definitive indication of whether failure will happen may mean inappropriate decisions are taken as a result of the analysis.
Defects:
+ Autocratic Chief Executives
+ Passive board, weak financial directors
+ Poor respond to changes
+ Lack of budgetary control, cashflow forecash, costing system
- Mistakes
+ Over-trading
+ Gearning
+ Failure of large project jeopardize the company
- Symptoms
+ Deteriorating ratios
+ Creative accounting
+ Declining moral or declining quality
