The failure of a business organization often has incur a serious economic loss and social cost for its owner, creditors, employees, customers and government.
The purpose of this study is first to present a practical prediction model of business failure for Korean manufacturing enterprises. Second, it is to test the usefulness of accounting information and especially cash flow information to the business failure prediction.
29 failed firms are selected and matched with 77 secured firms during the years 1997 through 1998, which are included in the electronic industry.
The multivariate statistical technique known as logit analysis was used to classify firms as failed or secured. This statistical technique compares 36 financial ratios of the failed firms with secured firms.
The results of this empirical study are as follow:
1) A quite accurate business failure prediction model between failed and secured firms was acquired. The model (integration model) correctly classifies 88.05% of the samples. This fine model was selected which best classify between failed and secured firms.
The logistic function is as follows:
E(Yi)=exp(-2.0905+0.5065*X9-0.0336*X14-0.0106*X17+0.0509*X21-0.0218*X34-2.9755*X35)/{1+exp(-2.0905+0.5065*X9-0.0336*X14-0.0106*X17+0.0509*X21-0.0218*X34-2.9755*X35)}
X9=(Financial expense/Sales)*100
X14=(Fixed assets/Total assets)*100
X17={(Net income+Depreciation+Financial expense)/(Short-term borrowings+Current long-term borrowings+Current debentures+Financial expense)}*100 X21=Sales/Inventories
X34=(Cash flows from operating activities/Current liabilities)*100
X35=(R&D amount/Sales)*100
2) The cash flow information is very useful for the prediction of business failure as much as traditional accounting information.
3) The business failure prediction model is useful for the decision of the commercial credit rating.
For the development of business failure prediction model in Korea, more intensive research, both theoretical and empirical, is required.
