International Finance and Accounting Handbook

(avery) #1

(e) Other U.K. Studies. Marais (1979), while on a short-term assignment for the In-
dustrial Finance Unit of the Bank of England, also utilized discriminant analysis to
quantify relative firm performance. He too concentrated on U.K. industrials and in-
corporated flow of funds variables with conventional balance sheet and income state-
ment measures. Using a sample of 38 failed and 53 nonfailed companies
(1974–1977), he tested several previously published models from the United States
and the United Kingdom using both univariate and multivariate techniques.
He then went on to develop his own model, of which space does not permit a full
discussion. His model included the following variables:


His results were considered “satisfactory” and his conclusions modest. He mainly
advocated that firms whose scores fell below a certain cutoff point should be re-
garded as possible future problems; “that all Z scores can hope to do is act as a so-
phisticated screening device to those firms most urgently in need of analysis” (p. 29).
A later work, by Earl and Marais (1982), expanded upon this work with more en-
thusiastically reported results and implications. Classification results of 93%, 87%,
and 84% respectively for the three years prior to failure are reported. The authors felt
that funds flow data improved their classification accuracy. The single ratio of cash
flow/current liabilities was a successful discriminator. Subsequent tests on failures
and nonfailures in 1978 revealed a very low Type I error but an unacceptably high
Type II error assessment.


10.6 CANADA. Canada, like Australia, is a relatively small country in terms of
business population, yet it too is concerned with the performance assessment of in-
dividual entities. The economy is very much tied to the fortunes of the United States
and its financial reporting standards are often derived from the same accounting prin-
ciples. Like many other environments, the key constraint in Canada is the availabil-
ity of a large and reliable database of failed companies. This requires both a sufficient
number of failures and publicly available data on those firms. Both attributes do exist
in Canada, but just barely.


(a) Knight (1979). Knight (1979) analyzed the records of a large number of small
business failures as well as conducting interviews with the key persons involved. The
author contends that his study supplies information “to answer the question, why do
small businesses fail in Canada and also generates certain guidelines as to how the
failure rate in Canada may be decreased from its recent increasing level.” Not sur-
prisingly, Knight finds that a firm usually fails early in its life (50% of all failed firms
do so within four years and 70% within six) and that some type of managerial in-
competence accounts for almost all failures.
Knight also attempted to classify failure using a discriminant analysis model. He
amassed a fairly large sample of 72 failed small firms with average sales and assets


capital to total debt

X 4 funds generated from operations minus net change in working

X 3 cash flow>current liabilities

X 2  1 >gross total assets

X 1 current assets>gross total assets

10.6 CANADA 10 • 15
Free download pdf