Financial Distress Prediction: A Comparative Study of Solvency Test and Z-Score Models with Reference to Sri Lanka

This paper examines the discriminant power of the solvency test of the Sri Lankan Companies Act in identifying insolvency of firms and whether the Z-score models of Altman and Springate appropriately predict financial distress in Sri Lanka. The study observes a sample of 82 firms listed on Colombo S...

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Bibliographic Details
Published in:The ICFAI journal of financial risk management 2014-09, Vol.11 (3), p.39
Main Author: Gunathilaka, Chandana
Format: Article
Language:English
Subjects:
Accuracy
Balance sheets
Bankruptcy
Business forecasts
Capital structure
Comparative analysis
Credit scoring
Decision making
Discriminant analysis
Finance companies
Financial performance
Independent sample
Manufacturing
Mathematical models
Public companies
Solvency
Solvents
Standard scores
Stock exchanges
Stockholders
Studies
Support vector machines
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Summary:This paper examines the discriminant power of the solvency test of the Sri Lankan Companies Act in identifying insolvency of firms and whether the Z-score models of Altman and Springate appropriately predict financial distress in Sri Lanka. The study observes a sample of 82 firms listed on Colombo Stock Exchange across different sectors, over a period of five years from 2008 to 2012. It analyzes company financials using independent sample t-tests and multivariate discriminant analysis. The study finds that the solvency test does not discriminate solvent and insolvent firms meaningfully. The Altman's and Springate's Z-score models yield similar predictive power. In particular, Altman's Z-model shows a higher degree of discriminant power in identifying financially distressed firms, at least one year prior to the distress. The market value and book value contribute similarly between Z-models. The study indicates the level of care required in solvency test-based decision making.
ISSN:0972-916X