Financial statement analysis and insolvency forecast models: a proposal for local firms

Abstract

Understanding in time premonitory signals of a distress situation and taking actions to get out of these situations are financial management primary targets. Numerous contributions in accounting and finance have presented a plethora of studies about the Insolvency Forecast Models (IFMs) based on a statistical approach especially discriminant analysis, logit and probit techniques. The main issue sometimes seems to be that statistically meaning variables are not so meaningful in accounting.

The aim of this paper is to estimate construction and verify an IFM based on an alternative statistical approach to the discriminant analysis techniques. A specific model, descriptive and predictive, was developed to analyze the economic and financial conditions of the firms, comparing them with a reference group, through the financial statement analysis. The business distress was studied through financial statement ratios and through successive analysis of their distributions. Two fundamental dimensions were taken into consideration: the economic one (like profitability and growth) and the financial one (liability, capital structure, liquidity).

The use of these two dimensions allowed to develop a graphical system in which it was possible to appreciate the positioning of every firm considered and their economic and financial situation. Moreover, a comparison among the firms was done in a static and dynamic context, in order to evaluate the changes in the financial risk and default likelihood.