The companies were drawn from the cement, electrical, engineering, glass, paper,
and steel industries.
The seven ratios in the final discriminant function, along with the standardized
discriminant function coefficient are presented in Exhibit 10.13.
The Type I accuracy was 87.1% and the Type II accuracy was 86.6% on the de-
velopment sample. A holdout test was performed on 20 healthy companies and 28
sick companies. The test results generally validated the efficacy of the model.
10.16 IRELAND. In Ireland, Cahill (1981) presents some exploratory work on a
small sample of 11 bankrupt, listed companies covering the period from 1970
through 1980. Three primary issues are explored: (1) identification of those ratios
which showed a significant deterioration as failure approaches, (2) whether the audi-
tors’ reports expressed any reservations or uncertainty about the continuance of the
firms as going concerns, and (3) whether there were any other unique aspects of the
failed companies’ conditions.
Cahill’s analysis revealed a number of ratios indicating clear distress signals one
year prior to failure. These ratios compared unfavorably with aggregate norms and
ratios for the comparable industrial sector. Although several measures continued to
show differences in earlier years, the signals were less clear in year 2 prior and it was
difficult to detect strong signals from ratios prior to year 2.
Only one of the 11 auditors’ reports was qualified on the basis of going concern.
Five other less serious qualifications were present in the auditor’s reports. Cahill
speculates that the low frequency of auditor qualifications on a going concern basis
was due to auditor reluctance and accounting convention in Ireland as well as their
feeling of being part of a “small society.” We observed similar circumstances in Aus-
tralia. Still, according to Cahill, since deterioration was quite apparent, those close to
the situation should have been aware of the seriousness of the situations and earlier
remedial action taken or qualification given.
Unsuccessful merger activity and significant investment and asset expansion fi-
10 • 36 BUSINESS FAILURE CLASSIFICATION MODELSStandardized Unstandardized
Coefficient Rank CoefficientX 1 0.56939 2 1.64621
X 2 0.23186 6 0.03071
X 3 0.34543 4 0.004271
X 4 0.50499 3 0.8169
X 5 0.64154 1 0.05372
X 6 0.14993 7 –0.007024
X 7 0.34498 5 0.006616
X 1 = Current ratio
X 2 = Stock of finished goods/sales
X 3 = Profit after tax/net worth
X 4 = Interest/value of output
X 5 = Cash flow/total debt
X 6 = Working capital management ratio
X 7 = Sales/total assets
Exhibit 10.13. Discriminant Function Coefficients.