Modelos del Marketing Digital

We have seen that ratio analysis is used to assess several factors of the firm’s performance including the financial stability, the return received from investment and the efficiency and effectiveness of management. We have also seen that inter-firm comparison can be a useful way of identifying the strengths and weaknesses of different companies, and as a tool to increase efficiency. It is also useful in predicting and identifying corporate failure.

A business that is highly dependent on one major customer or one major supplier, must monitor that company’s activities in order to detect any early warning signs of potential collapse which leave those who deal with it with potentially serious problems. A further reason for monitoring the progress of companies is when the managers of the firm are seeking a takeover opportunity, at which time they may be reviewing certain businesses to see which could be the most suitable targets for acquisition.

The problem of corporate collapse is a serious one; empirical evidence shows that for every company which is in receivership there are three or four others with serious cash constraints.

Many such businesses are at risk of second-round failure, which we discussed in the previous unit.

Avoiding the pitfalls which the managers of such firms are likely to face will require, among other things, careful control of debtor and creditor relationships. The quality of credit control in the firm may, in these circumstances, mean the difference between survival and disaster, by ensuring that the firm always has sufficient funds to pay its obligations thus avoiding

liquidation. Time spent in credit control should be regarded as equally important as time spent developing new business.

Company Information Services

Besides specialists in the field of inter-company comparison, there are several organisations that provide company information services. They include:

(a) Performance Analysis Services

Performance Analysis Services was formed to collect and collate results of some 800 of Britain’s largest, listed, industrial companies. From data collected, the company has developed ways of predicting firms that appear to be most at risk of receivership.

(b) Dun and Bradstreet

Dun and Bradstreet are suppliers of financial information and related services and they, too, have developed an early warning system on possible company failures. The service is based on Stubbs Gazette, which is used as a key source of information, providing up-to-date information on compulsory winding-up orders, voluntary liquidations, court judgments, mortgages and charges.

(c) Institute of Chartered Accountants in England and Wales (ICAEW)

ICAEW has produced an operational guideline on the continuity of business, which identified a number of factors which put continuity into question:

 Loss of key management and staff

 Significantly higher stock levels, without the apparent source of finance to pay for them

 Regular work stoppages and labour disputes

 Dependence on a single product or project

 Dependence on a single supplier, or a large customer

 Outstanding legal proceedings

 Political risks

 Technical obsolescence

 Loss of a major franchise or patent

 History of poor performance within the industry.

Clearly it is the trend towards the regular occurrence of several factors which is

important, not a single “one off” event in isolation. If there should be a build up, then it could lead to a situation of “crisis management”, i.e. where managers are dealing with one serious problem after another rather than focusing on planning for the future needs of the business.

In extreme circumstances, managers may have no option but to slim down the entity resulting in lower, but more manageable, operating capacity. However, not every manager will be willing to sacrifice the prestige of running a business of a certain size.

Many problems stem from the failure of managers to react in time (if at all).

The Z Score

The analysis of financial ratios is generally concerned with the assessment of the

effectiveness and efficiency with which a company deploys its resources. This is in itself an attempt to measure the overall financial stability of the organisation – you will remember that this is a principal duty of the financial manager.

An American, E.I. Altman, researched the use of ratio analysis in order to examine ratio correlation and business failure. In his research he looked simultaneously at several ratios to attempt to predict business failure. He used some 22 accounting and non-accounting ratios which he applied to a selection of failed and continuing US companies. From this initial analysis, he determined that there were five key indicators of impending failure, and he used them to formulate the Z Score.

Using the Z score, Altman predicted that firms with a score below a certain level were much more likely to fail than those with higher scores, and he identified “middle ground” in which the outcome of the company’s future was uncertain.

Other Models (a) Argenti

This model, also known as Argenti’s failure model, is based on the calculation of a company’s scores in the areas of defects of the company, management mistakes and symptoms of failure.

Company defects include a passive board, an autocratic Chief Executive and weak budgetary control. Managerial mistakes include high levels of gearing and the failure of a large (in relation to the company) project. Overtrading (the business expanding too quickly for its level of cash funding and thus having insufficient liquid funds to pay creditors) is also noted as a major managerial mistake. Symptoms of decline include deteriorating ratios, quality and staff morale and the use of window dressing. Each of these three areas has a danger mark.

Argenti based his model on past company data and, as with the other models, it is difficult to assess its predictive ability.

(b) Taffler

Taffler has developed a model to predict business failure which is based on a series of ratios:

 Sales/total assets

 The current ratio

 The reciprocal of the current ratio

 Earnings before tax/current liabilities.

(c) Beaver

Empirical research conducted by Beaver found that the best prediction of corporate failure is a low cash flow/borrowings ratio, and the poorest measure for forecasting failure is the current ratio (current assets/current liabilities).

Other Indicators

One quick method of predicting company failure is the use of the liquidity ratios – proponents of this method state that a current ratio of below 2 : 1 and an acid (quick) ratio of less than 1 : 1 means that the firm is illiquid and liable to fail. However, as we discussed earlier, these ratios need to be viewed in the light of the nature of the business and the overall position of the firm. Moreover, empirical evidence (see Beaver above) has found that these ratios, and trends in them, give little or no indication of eventual business failure. A worsening liquidity position could, however, indicate that the firm is having problems and its financial and operational performance should be carefully scrutinised.

Other accounting information which may provide indications of financial difficulties include important post balance sheet events, large contingent liabilities and large increases in intangible assets.

Non-accounting information contained in the annual report may also provide indications of company problems, as may changes in the composition of the board if the more able

directors have left. In addition, the Chairman’s Report, although generally optimistic (and not audited), may discuss current and future unsolved problems.

External events such as legislation, political changes at home and abroad, competitors’

actions, and changes in economic variations (e.g. interest and exchange rates) may also give forewarning of potential problems for a firm. In addition, newspapers and journals may report on the financial and other difficulties a firm is or may be experiencing.

Problems with Prediction Models

There are several problems with the use of the above models:

 Many assumptions have to be made in interpreting information, including the methods of accounting which have been used. Indeed, any limitations in the accounting data used will also affect the models.

 It is difficult to value the equity in a private company, which may make the use of the models for private company analysis difficult and extremely subjective.

 The information they use reflects the past and thus is out of date. The problem is exacerbated by the delay in the publication of company accounts.

 Prediction models take little or no account of economic conditions occurring when they are used, and the effect that economic variables may have on the figures used in their models.

 It is very difficult to define corporate failure because companies which would otherwise have been liquidated can be “rescued” or taken over. Similarly, businesses may close for reasons other than failure, e.g. a private company may cease to operate because the owner-manager wishes to retire.

 Companies may manipulate the measures used in the models in order to prevent predictions of failure.