Academic field of insolvency forecasting
Predictions regarding whether or not a patent will be lodged constitute a field of study. In the academic world, there are a large number of experts who evaluate the issues faced by various people/companies and determine whether or not they will file for bankruptcy. They employ various models, some of which are described below:
Altman's Model
Edward Altman is regarded as the guru of bankruptcy predictions due to a 1968 method he devised for predicting when and under what conditions individuals can file for bankruptcy. He developed his model using a multiple discriminate analysis with a high frequency of accurate results. Almost 91% is the accuracy rate he attained with his model results. He sampled approximately 66 businesses, of which 33 were successful and 33 were unsuccessful. He designed his model as follows:
Z = 1.2A + 1.4B + 3.3C + 0.6D + 0.99E
Where:
A - Working capital in relation to total assets
B - Retained earnings as a percentage of total assets owned
C - EBIT ratio to total assets
D -Market value of equity in relation to total book value of debts
E - Sales to total assets
If Z is less than 2.675%, the company is considered to have failed. The Fulmer Model is another model that predicts the likelihood of a company declaring bankruptcy.
Fulmer Model
In the 1980s, Fulmer applied the same discriminatory analysis to sixty (half failed, half successful) companies with varying financial ratios and an average asset value of approximately $450,000. His design is as follows:
H = 5.528 (V1) + 0.212 (V2) + 0.073 (V3) + 1.270 (V4) - 0.120 (V5) + 2.335 (V6) + 0.575 (V7) + 1.083 (V8) + 0.894 (V9) - 6.075
Here are his stated values:
V1 - Profits retained/total assets possessed
V2 - Sales to total assets
V3 - EBT/Total equity
V4 - Cash Flow/Total Obligations
V5 - Total debts/Total assets
V6 - Current liabilities/Total assets
V7 - Log tangible total assets
V9 - Log EBIT/Interest V8 - Working Capital/Total Debt
If the value of H is less than zero, the company is considered to have failed. Compared to the aforementioned model, this physicist reported 98% accurate results. He stated that he could predict a company's success or failure a year in advance.
If a business wishes to learn more, it should hire professional financial advisors to prevent bankruptcy, reduce debt, and manage financial issues.
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