2.Profitability: (operating income + ordinary depreciation + addition to pension
reserves)/total assets
3.Financial Strength: (cash income including extraordinary income – cash ex-
pense including extraordinary expense)/short term liabilitiesRather than using the cutoff point as the basis for separating the firms into good
and bad groups, the authors created a gray area around the cutoff point where the
probability of assigning to either group was low. By doing so they were able to put
the predictive accuracy of the model in a clearer perspective. The discriminant func-
tion was subsequently tested with about 40,000 financial statements of all corporate
customers of the bank. The results of the tests were quite similar to that found on the
analysis sample. The model proved very stable when tested using a simulation model
developed at Gottingen University.
10.5 ENGLAND
(a) Taffler and Tisshaw (1977). Taffler and Tisshaw (1977) have approached the cor-
porate distress problem primarily from the viewpoint of security analysis and adap-
tations of their work, and that of Taffler and Houston (1980) and Taffler (1976). They
indicate that their model is also relevant for accounting firms to assess the going con-
cern capability of clients and in their work as receivers and liquidators of firms that
have already failed.
(b) Research Design. To construct their solvency model, Taffler and Tisshaw (T&T,
1977) utilized linear discriminant analysis on a sample of 46 failed firms and 46 fi-
nancially sound manufacturing companies. The latter sample was matched to the
failed sample by size and industry (no information on these characteristics is avail-
able), from the period 1969 through 1975. Failed firms were those entering into re-
ceivership, creditors’ voluntary liquidation, compulsory winding up by order of the
court, or government action (bailouts) undertaken as an alternative to the other un-
fortunate fates. Eighty different ratios were examined for the two samples with a re-
sulting model utilizing only four measures. These four were:
The first three ratios are taken from the balance sheet and measure profitability,
liquidity, and a type of leverage, respectively. The no-credit interval is the time for
which the company can finance its continuing operations from its immediate assets if
all other sources of short term finance are cut off. More directly it is defined as im-
mediate assets-current liabilities/operating costs excluding depreciation. T&T state
that the no-credit interval is “something akin to the acid-test ratio” (p. 52).
(c) Empirical Results. Both the model described above and an “unquoted model”
(for non-listed companies) appeared to be quite accurate in classifying correctly over
97% of all observations. Another model by Taffler (1976), supposedly the one being
X 4 no-credit intervalX 3 current liabilities>total assetsX 2 current assets>total liabilitiesX 1 profit before tax>current liabilities10.5 ENGLAND 10 • 13