Business failure leads not only economial losses to stakeholder, also mislocation of social resources and decreases in social wealth. Predicting the potential failure, therefore, is very important to the society and stakeholders.
Many studies on this matter have been made since the early 1900's. Numerous business failure prediction models are produced by financial models using financial ratios, stock market information, but, due to the sample size and dynamic changes of environmental situation these studis have limitations in implication.
The purpose of this paper can be summarised as followings
First. find the new variables for better describing the company failure. Second, evaluate the compnay riskness as a probability using probit analysis as an early warning system to avoid the unhopeful situation. Third, suggest the major actions in financial ratios year by year for recover the company's health. Forth, match the failure process between qualitative analysis and quantitative analysis that could be explain more easily the steps of the compaly failure process by time.
This paper uses 140 manufacturing companies listed in Korea stock market as a sample. 120 companie are used modeling the company failure as paired matching sampling method(60 failed, 60 normal companies), and 20 companises are used as a holdout sample.
Financial ratios are calculated on the financial statement after selecting the financial ratios which are recognized as useful one in prior studies for predicting the company failure, and use the Probit and Correlation analysis for the failure modeling , and use the SAS program for data treatments.
As a result of this empirical study, get the followings.
1) Important factors to explain the company failure
1st year before bankrupcy : Total borrowings and bonds payable to total assets, Payables turnover, Growth rate of net income to capital stock/Growth rate of stockholder's equiy, Inventories turnover/Payables turnover, Gross value added per capita or productivity of labor. Rate of selling and administrative expenses to gross sales are impotant factor of company's robustness.
2nd year before bankrupcy : Total borrowings and bonds payable to total assets, Turnover of the total capital, Payables turnover, Inventories turnover/Payables turn over.
3th year before bankrupcy : Net income to capital stock, Interest expenses to total expenses, Inventories turnover/Payables turn over.
2) Hit ratios of predicting the company failure.
Results of empirical studies for 3 years before bankrupcy, using 52 variables get the 78.3%, 75.0%, 73.3 % hit ratios each year and applying the first year model before bankrupt to the second, third year, also get the 75%, 72% hit ratios each for failure company.
3) Prediction of the expected time for company failure.
Using the weighted least square regression method, identified relationships between the probability of company failure and expected failure time that can be useful for setting the strategic business plan and reengineering.
The other usefulness of these empirical study is partialy match the process of company failure suggested by Newton and Argenti and interprete for the Korean manufacturing companies.
