Financial Crisis Warning Analysis

IOne of the most significant threats for many businesses today, despite their size and the nature of their operations, is insolvency. Extant evidence shows that in the past decades business failures have occurred at higher rates than at any time since the early 1980's in China. The economic cost of business failures is relatively large. Evidence shows that the suppliers of capital, investors and creditors, as well as manager and employees are severely affected from business failures. The auditors will also face the threat of a potential lawsuit if they fail to provide early warning signals about failing firms through the issuance of qualified audit opinions. Indeed, the need for reliable empirical models that predict corporate failure promptly and accurately is imperative, in order to enable the interested parties to take either preventive or corrective action. Although a substantial volume of failure prediction studies has been published since Beaver's pioneering work (1966), research interest has also continued from that time, especially in the US and UK. However, few researches in this area were conducted in China. The majority of China corporate failure prediction studies were focused on the area of listed companies in recent years. The main objective of this study is to develop reliable failure classification models based on the latest possible financial data for China state-owned industrial firms. This study proceeds as follows. Section I introduction; how traditional ratio analysis predict distress is presented in section II, including modification and development of traditional financial analysis on special area; section III is about research review; the research design is presented in section IV; the empirical results are presented and analyzed in section V; conclusions and advises are presented in section VI.IIa. Traditional Ratio AnalysisThe detection of company operating and financial distress is a subject that has been particularly amenable to analysis with financial ratios. Prior to the development of quantitative measures of company performance, traditional ratio analysis was established certain important generalization regarding accessing the bankruptcy potential of firms. However, ratio analysis, both theoretically and practically, is susceptible to interpretation and is potentially confusing. The crux of the shortcomings inherent in traditional ratio analysis lies in its insufficiency and high cost. b. Empirical research designFirst, we discuss the data set. Secondly, selection of predictor variables. Thirdly, using Kolmogorov-Smimov (K-S) method and Q-Q Probability Plot test the normal distribution of predictor variables. Forthly, if the major financial variables are found statistically significant, we use T value test mean deviation and develop multiple discriminant models. Otherwise, Mann-Whitney-Wilcoxon (M-M-W) method will be used to test mean deviation and develop logistic model. Prediction models are developed for up to five years prior to the failure event. Moreover, the models are validated by using an out sample period ex-ante test. In addition, we try to use factor analysis to reduce data.c. Data setThe initial sample is composed of 70 enterprises with 35 firms in each of the two groups. The bankrupt (distressed) group are stated-owned manufacturers that filed a bankruptcy petition under China Bankruptcy Act (1986) or have suffered from business failure from 1999 to 2001. Holdout samples for the period 2002, which composed of 26 enterprises with 13 firms in each of the two groups, are used to test the model. In consistent with the majority of prior insolvency prediction studies, the nondistressedfirms were matched to the failed group by industry, asset size and fiscal year. The financial information needed for this study was collected from the information system of People's bank of China. d. Selection and test of predictor variablesThe ratios are chosen on the basis of their popularity in the literature and their potential...