Prediction of Corporate Bankruptcy in Nepal

Ghanendra Fago 1
ABSTRACT
The main objectives of the study is to discriminant and develop multiple discriminate models of financial
ratios and find the best financial ratio(s) as the best predictor(s) in prediction of corporate bankruptcy in the
context of Nepal. The study of predictive power of financial variables using multivariate discriminant
analysis (MDA) is perhaps first in Nepal. Using pooled crossed sectional data, this study concludes that
there are significant differences of financial ratios of bankrupt and non-bankrupt manufacturing companies
and most of the selected financial ratios of bankrupt and non-bankrupt companies have been found always
lowers in three years prior to bankruptcy. It has been found that original classification was found 92% accurate
while discriminating them on the basis of ten selected financial variables. Out of ten financial variables CACL,
RETA EBITTA and TDTA have been found the ratios with high discriminating power in failure prediction
context of Nepal.

1. Background of the Study

Bankruptcy is defined as the inability of a firm to pay its financial obligations. A firm can
be said bankrupt its has overdraw bank account, huge amount of accumulated loss,
accumulated loss exceeds it paid up capital, non-payment of preferred dividend, tax,
salary and wages to employees etc. This can be viewed as technical and real insolvency as
well. Bankruptcy can be viewed strictly in the legal sense of liquidation while it can be
taken to be financially distress when it begins to occur loss, default in payment of loans,
operating cash shortage etc (Beaver, 1966). A firm is regarded financially distressed or
bankrupt when it is not likely to continue its operations, or pay dividend to its
shareholders or pay wages to its employees (John, 1993). Corporate bankruptcy does not
necessarily results in the collapse and dissolution of a firm. In another sense, it means it is
losing money. Its liabilities are increasing that assets are being insufficient for collateral
of obligations. It accumulated loss in increasing that being exceed the capital. Like many
reasons of corporate bankruptcy, there are many views and opinions of about the
corporate bankruptcy. No unanimous meaning of corporate bankruptcy of a firm can be
found.
There are many empirical works carried out by different authors and researchers in area
of financial analysis and bankruptcy to compare the bankrupt and non-bankrupt
companies. Studies were Ramser and Foster (1931, Patrick (1932), Winakor and Smith
(1935), Mervin (1942), (Hickman, 1958), Saulinier and et al: (1958) and concluded that
the financial ratios of failed firms tented to have been lower than the firms that are more
successful different from non-failed firms and ratios of trend that had directed towards
corporate bankruptcy.
Beaver’ study (1966), the pioneer study using univariate statistics of financial ratios
concluded that ratios distribution of failed firms begins to deteriorate at least the five
years before failure. Like Beaver (1966), Altman (1968) had used multivariate
discriminate analysis to assess predictive power of ratio analysis and concluded five
financial ratios WVTA, RETA, EBITTA, MVBV, and STA, possesses high predictive
power in bankruptcy prediction context.
After Beacver (1966) and Altman (1968) there are numerous studies in the area of
corporate bankruptcy and corporate failure. They are Meyer and Pifer (1970), Deakin
(1972), Libby (1975), Ohlson (1980) (Dambolene and Khoury, 1980 Aizi and Lawson
(1989) Coats and Fant,(1993, Matsumoto et al. (1995), Gibson (1987), Pradhan, (1986)
Shrestha et al:, (2003). These studies were conducted for development of statistical
models and determine the predictive power of financial ratios that are useful in prediction

1
Ph D Scholar and Faculty of Shanker Dev Campus, Faculty of Management, Tribhuvan University
of corporate bankruptcy in developed countries. Many statistical techniques found
financial variables or ratios useful in predicting corporate failure and solve many other
business issues. However, no such study has been carried out in the context of Nepal. As
an attempt, this study has been made to develop statistic model of financial ratios for
prediction of corporate of bankruptcy of bankrupt and non-bankrupt manufacturing
companies.

The main objectives of the study is to discriminant and develop multiple discriminate
models of financial ratios and find the best financial ratio(s) as the best predictor(s) in
prediction of corporate bankruptcy in the context of Nepal. Other specific objectives are
to measure how financial ratios deteriorate when firms moves towards financial
bankruptcy, to observe and test the significance differences between bankrupt and Non-
bankrupt manufacturing companies.
This chapter has been divided into five sections. The section 1 deals with background of
studies and review of literature is described in second 2. In section 3, research design,
nature and sources of data and method of data analysis have been explained. While in
section 4, profile analysis of bankrupt and non-bankrupt companies and various
discriminant runs undertaken to arrive at an appropriate model, relative contribution of
financial variables, classification accuracy analysis of underlying assumptions in valid
application of MDA. At last, conclusions of the study are mentioned.
2. Review of Literature
The main objective of this section is to review empirical works carried out by different
authors and researchers in area of financial analysis and bankruptcy that how financial
ratios of failed firms are different from non-failed firms and ratios of trend that had
directed towards corporate bankruptcy.
Ramser and Foster (1931, Patrick (1932), Winakor and Smith (1935), Mervin (1942),
(Hickman, 1958), Saulinier and et al: (1958) used financial ratios to compare failed firms
and non-failed firms, loan defaulter and non-defaulter, bankrupt and non-bankrupt firms
evidenced that financial ratios are found differences between bankrupt and non-bankrupt
firms prior years to failure.
The pioneer univariate analysis of Beaver (1966), concluded that ratios distribution of
failed firms begins to deteriorate at least the five years before failure. Although ratio
analysis provides useful information, no all ratios can predict well equally. Like Beaver’s
study, Altman (1968) had used multivariate discriminate analysis to assess predictive
power of ratio analysis. Altman developed the following discriminant function as
prediction model of corporate bankruptcy.
Z = 0.012WCTA1 + 0.014RETA + 0.033EBITTA + .006MVBV + 0.999 STA5
The Z-score of less than 1.8 indicates a very high probability of failure, while a Z-score
larger than 3 indicates a high probability of non-failure. Z-scores between 1.8 and 3 fall in
the “grey zone” where it is not possible to predict with confidence whether the firm will
or will not fail.
Edmister (1972) concludes that ratios may be useful in predicting small business failure
as it is for predicting failure of medium and large business, where three annual statements
are available for analysis. It also concludes that predictive power of financial ratio is
cumulative. No single ratio predicted failure nearly as well as small group of variables
and which were not significant predictors alone added discriminating ability to a function
containing selected other variables. In 1970, Altman study resulted 97.7% correct
classification at one and two years prior to bankruptcy and provides evidence for validity
model through subsequent replication test. Libby (1975) was carried out to study

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consistency of interpretation of ratios within bank loan officers over time and between
bank loan officers. The study concludes that the prediction achievement was superiors
over the random performance because of accurate utilization of information. However,
prediction achievement between groups was found no difference and subject predictions
do not vary greatly across time. Dambolena and Khoury (1980) showed that standard
deviation of ratios showed significant differences between bankrupt and non-bankrupt
companies prior year to failure.
Gently et al. (1985) attempted to determine whether relative fund flow components by
themselves can discriminant bankrupt and non-bankrupt firms using MDA, logit and
probit models and concluded that three year prior to failure, the mean of the each variable
did not improved classification of the bankrupt and non-bankrupt companies. Casey and
Bartczak (1985) examined univariate predictive value of operating cash flows in contrast
to other related data and suggested the operating cash flow data do not provided
incremental predictive power over the accrual based ratios. Gombola, Haskins and
Williams (1987) attempted to assess the importance of operating cash flow in predicting
corporate failure after the 1970s using LDA. The study evidenced that cash flow from
operations is insignificant in predicting bankruptcy three years out of four as measured by
the significant of the coefficients. Shirata (1998) proved that Japanese bankrupt firms had
indicated their worse financial position for a considerable time before they actually went
bankrupt.
After Beacver (1966) and Altman (1968) there are numerous studies in the area of
corporate bankruptcy and corporate failure. Many statistical techniques found financial
variables or ratios useful in predicting corporate failure and solve many other business
issues. However, no such study has been carried out in the context of Nepal using statistic
model of financial ratios for prediction of corporate of bankruptcy of bankrupt and non-
bankrupt manufacturing companies.

3. Data and Methodology

Research Design
This study is a descriptive and analytical research based on secondary data. Research
work is designed to obtain the answers of all research questions raised and to develop
discriminant financial model for the purpose of prediction of corporate bankruptcy by
decision makers.
Nature and Sources of Data
Of twenty five (25) manufacturing companies, eleven firms categorized as failed and 14
non-failed firms (Annexure-I). In this study, a manufacturing company has been
considered bankrupt if the firm has been operating in loss at least three years or more
otherwise they are non-bankrupt manufacturing companies.
In this study, pooled cross sectional data of 1986 -2005 have been used. Data was
collected from annual reports of listed companies published by The Nepal Stock
Exchange Ltd which contain the balance sheets, and profit and lost accounts of listed
companies.
Method of Data Analysis
Various methods have been used in data analysis in previous researches. However, in this
study, only two techniques have been used: (1) Profile analysis of bankrupt and non-
bankrupt companies and (2) Canonical Multivariate Discriminant Analysis (MDA).

Profile Analysis of both Bankrupt and Non-bankrupt Companies

In this study, weighted mean of ten financial ratios of bankrupt and non-bankrupt
manufacturing companies have been presented in scatter graph to study the differences

3
between the failed firms and non-failed firms and study the behavior of financial ratios of
bankrupt and non-bankrupt manufacturing companies prior year to failure.

Multivariate Discriminant Analysis (MDA) and Corporate Bankruptcy

Ten financial ratios have been taken from previous studies for the purpose of this study to
develop Multivariate discriminant functions (MDF) for the purpose discriminating firms
into bankrupt and non-bankrupt on the basis of these selected variables in the context of
Nepal. Using SPSS procedure, Multivariate discriminant functions has been developed as
follows:
Z = + α1 WCTA + α2 RETA + α3 EBITTA + α4 MVBV + α5STA+ + α6 CFTA+α7
CACL+ α8 NPTA + α9 TDTA + α10 NINW
Z = Overall index or Score of the equation and While α1, α2, α3, α4, α5, α6, α7 α8, α9,
and α10 indicates the coefficients of each ten variables respectively.
This function transforms the individual variable values to a single discriminant score, or z
value, which is then used to classify firms into bankrupt and non-bankrupt manufacturing
companies.
4 Empirical Results
Section four is fully devoted to analyzing the various issues of this study in the context of
the selected listed manufacturing companies of Nepal. This study contains profile analysis
of bankrupt and non-bankrupt companies bankrupt and non-bankrupt companies,
descriptive statistics of financial ratios of bankrupt and non-bankrupt companies, test of
group means between bankrupt and non-bankrupt companies, multivariate discriminant
classification accuracy, multivariate discriminant function, and relative contribution of
financial variables and concluding remarks

4.1 Profile Analysis of Bankrupt and Non-bankrupt Manufacturing Companies

The mean of the ratios of each ten variables has been computed for bankrupt and non-
bankrupt companies of the three years before failure. Then these mean of the ratios of
each variables of two groups have been compared with each other. This is not a predictive
test rather helps to outline the general relationship between failed firms and non-failed
firms. This analysis helps in comparison with previous studies, since the analysis is based
entirely upon the mean value.
Figure-1
Working Capital to Total Assets Ratio
This figure presents ratio of working capital and total assets of three years prior to bankruptcy.
Working capital means net working capital obtained from current assts less current liabilities.
Total assets include currents assets, fixed assets and other assets.
Bankrupt Firm s
Nonbankrupt Firm s
0.20

0.10
0.00
1 2 3
-0.10
Ratio

-0.20
-0.30

-0.40

-0.50
-0.60

-0.70
Years Prior Bankruptcy

4
The above figure-1 shows that working capitals of bankrupt manufacturing companies are
negative in all three years. Thus ratios of WCTA bankruptcy manufacturing enterprises
are negative while they are positive for non-bankrupt manufacturing companies. The rate
of deterioration of these ratios of bankrupt manufacturing companies has been observed
higher than non-bankrupt companies.
Figure-2
Retained Earnings to Total Assets Ratio
This table shows the ratios of retained earning to total assets. Retained earnings refer the accumulated
profits of a firm or company. It is obtained by adding current year’s profit (loss) in previous year
accumulated profit. Current assets, fixed assets and other assets are included in total assets.

Bankrupt Firms
0.30 Nonbankrupt Firms

0.20

0.10

0.00
1 2 3
-0.10
Ratio

-0.20

-0.30

-0.40
-0.50

-0.60
-0.70
Years Prior to Bankruptcy

This figure-2 evidenced that the ratio of retained earnings to total assets begins to decrease
three years prior to bankruptcy with negative retained earnings. Thus, it can be said that
ratio of retained earning to total assets of non-bankrupt manufacturing companies.
Figure - 3
Earning Before Interest and Taxes to Total Assets Ratio
This figure presents the ratio between earning before interest and taxes (EBIT) to total (TA). EBIT is
computed by adding provision for income tax and interest expenses in net income (loss) of the year.
Total assets are obtained from current assets, fixed assets and others assets like investments.
Bankrupt Firms
0.15
Nonbankrupt Firms

0.10

0.05

0.00
Ratio

1 2 3
-0.05

-0.10

-0.15

-0.20
Years Priors to bankruptcy

Figure-3 indicates that EBIT of bankrupt company is either very low or negative. Earning
is insufficient to pay interest and no taxes are payable by bankrupt manufacturing
companies. Non-bankrupt manufacturing companies are either positive or sufficient to
meet interest expenses in all three years.
Figure 4
Market Value (Net Worth) to Total Book Debt Ratio

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This figure presents the ratio of market value to total book debt. Market value refers net worth while
total book value includes both current liabilities and long-term liabilities.
Bankrupt Firms
0.70
Nonbankrupt
0.60
0.50
0.40
0.30

Ratio
0.20
0.10

0.00
-0.10 1 2 3

-0.20
-0.30

-0.40
Years Prior to Bankruptcy

The net worth of bankrupt companies is nil (i.e. increasing negatively) while positively
increasing for non-bankrupts (Figure-4). This resulted no collateral value to debt holders
of bankrupt manufacturing companies. The net worth of non-bankrupt companies is
positive but is also less their total liabilities.
Figure 5
Sales to Total Assets Ratio
This figure presents trend of sales to total assets ratio of three years prior to bankruptcy. Sales
refer gross sales less returns. Total assets includes current assets, fixed assets and other assets

Bankrupt Firms
1.40
Nonbankrupt Firms

1.20

1.00

0.80
Ratio

0.60

0.40

0.20

0.00
1 2 3
Years Prior to Bankruptcy

Figure-5 shows no significant difference of the ratios of sales to total assets of both
bankrupt and non-bankrupt companies of three years prior to bankruptcy. However, sales
to total assets ratio is observed lower in bankrupt companies.
Figure 6
Cash flow to Total Debt Ratio
This figure explains the trend of cash flow total debt ratio of three years. Cash flow is computed by
adding depreciation and non-cash expenses in profit of each year. Total debt includes current
liabilities and long term liabilities.

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 Bankrupt Firms
0.20
Nonbankrupt Firms
0.15

0.10

0.05

Ratio
0.00
1 2 3
-0.05

-0.10

-0.15

-0.20

Years Prior to Bankruptcy

The figure-6 evidenced that cash flows of the bankrupt manufacturing companies are
insufficient to operating requirements. Thus, no fund is available for repayment of
liabilities while it seems positive in case of non-bankrupt companies.
Figure 7
Current Assets to Current Liabilities Ratio
This figure represents relationship between current assets and current liabilities of three years prior
to bankruptcy. Current assets include cash, inventory, bills receivables, and prepaid expense while
bills payables and expenses payables are included in current liabilities.

Bankrupt Firm s
2.00
Nonbankrupt Firm s
1.80

1.60
1.40
1.20
Ratio

1.00
0.80
0.60

0.40
0.20
0.00
1 2 3
Years Prior to bankruptcy

Figure-7 expresses the current ratios indicating that all in all three years prior to
bankruptcy for bankrupt companies and non-bankrupt manufacturing companies where
CRCL of bankrupt companies is less 1 and while more than 1 for non-bankrupt
manufacturing companies.
Figure 8
Net Income to Total Assets Ratio
This is graphic presentation of net income to total assets ratio. Net income refers profit after tax
while total assets include both current assets and non-current assets. This ratio is obtained dividing
net income by total assets.

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 Bankrupt Firms
0.10
Nonbankrupt Firm s
0.05

0.00
1 2 3
-0.05

Ratio
-0.10

-0.15

-0.20

-0.25

-0.30
Years Prior to bankrutpcy

This figure proves that bankrupt manufacturing companies’ losses are increasing while
profits to non-bankrupt companies at the beginning years. The ratios of last three years of
bankrupt manufacturing companies are the lower (i.e. negative).
Figure 9
Total Debt to Total Assets Ratio
This figure presents the ratio of total debt to total assets. In total debt, both long-term and current
liabilities have been included. Similarly, current assets and non-current assets arte included in
total assets.
Bankrupt Firms
1.80
Nonbankrupt Firms
1.60

1.40

1.20

1.00
Ratio

0.80

0.60

0.40

0.20

0.00
1 2 3
Years Prior to Bankruptcy

Total assets indicate the collateral values of bondholders of company. In figure-9, the
levels of total liabilities are higher than collateral of bondholders of bankrupt companies.
It seems positive in the context of non-bankrupt companies.
Figure 10
Net Income to Net Worth Ratio
This figure presents the trend of net income to net worth ratios of bankrupt and non-bankrupt
companies of last three years. Net income refers the profit after tax while net worth is computed
by summing up capital and undistributed profit (loss).

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 Bankrupt Firms
0.80
Nonbankrupt Firms
0.60

0.40

0.20

Ratio 0.00
1 2 3
-0.20

-0.40

-0.60

-0.80
Years Prior to Bankruptcy

This figure evidenced that net income of non-bankrupt companies is lower and began to
occur loss, while ratio net income to net worth is improving in case of bankrupts firms
against non-bankrupt manufacturing companies in last two years.
4.2 Descriptive Statistics of Financial Ratios of Bankrupt and Non-bankrupt
Companies
To observe whether the difference in the financial ratios of bankrupt companies and non-
bankrupt companies, average ratio and standard deviation of bankrupt and non-bankrupt
companies have been computed.
Table - 1
Descriptive Statistics of Financial Ratios

Table -1 provides descriptive statistics of mean, and standard of ten financial variables (ratios) of
bankrupt companies and non-bankrupt companies that are obtained from pooled cross section data
of 25 manufacturing companies in panel-A, Panel-B and Panel-C respectively.

Panel A: Descriptive Statistics of Bankrupt Companies

WCTA RETA EBITTA MVBV STA CFTD CACL NPTA TDTA NINW
Mean -0.50 -0.54 -0.04 -0.25 0.94 -0.10 0.58 -0.17 1.48 0.62
Std. 0.48 0.51 0.15 0.24 0.67 0.134 0.21 0.19 0.68 1.18
N 11 11 11 11 11 11 11 11 11 11
Panel B: Descriptive Statistics of Non-bankrupt Companies
Mean 0.13 0.14 0.09 0.45 1.08 0.12 1.48 0.02 0.68 0.00
0.27 0.21 0.09 0.50 0.96 0.19 0.53 0.10 0.38 0.22
N 14 14 14 14 14 14 14 14 14 14
Panel C: Descriptive Statistics of Total Selected Manufacturing Companies
Mean -0.15 -0.16 0.03 0.14 1.02 0.03 1.08 -0.07 1.03 0.27
Std. 0.49 0.50 0.14 0.54 0.83 0.20 0.61 0.17 0.66 0.84
N 25 25 25 25 25 25 25 25 25 25

Panel-A indicates summary of selected average ratios of bankrupt companies that

9
financial ratios seems to be more deteriorating. The companies that exhibit lower CACL
ratio, NINW while high TDTA. The remaining ratios are negative.

Panel-B indicates that numbers of financial ratios of non-bankrupt companies are either
positive or satisfactory compared to bankrupt companies. However, NINW of bankrupt
manufacturing companies are more satisfactory compared to no bankrupt manufacturing
companies.

Panel C- results the combined financial ratios obtained from both bankrupt and non-
bankrupt companies. This ratio shows that WCTA, RETA and NPTA are negative while
others are either satisfactory or positive.

4.3 Tests of Equality of Group Means between Bankrupt and Non-Bankrupt

Companies
To test whether the statistically differences of financial ratios between bankrupt and non-
bankrupt companies, t-statistics, f-statistics and p-values have been computed. This helps
to determine the significant and insignificant variables between groups for the purpose of
discriminant analysis.
Table - 2
Tests of Equality of Group Means
This table contains mean of each group, mean differences, t-statistics, Wilks' Lambda, the F-
statistic, and degree of significance (i.e. p-value). Wilks’ Lambda ranges from 0 to 1. It is the ratio
of the within-groups sum of squares to the total sum of squares. Small value indicates strong group
differences and values close to 1 indicate no group difference. T-statistics at 95% significance level.

Non- Mean t-
Ratios Bankrupt Wilks' Lambda F-statistics Sig.(p-value)
bankrupt Difference statistics
WCTA -0.50 0.13 -0.64 -4.22 0.56 17.80 0.00
RETA -0.54 0.14 -0.68 -4.56 0.53 20.79 0.00
EBITTA -0.04 0.09 -0.13 -2.52 0.78 6.33 0.02
MVBV -0.25 0.45 -0.70 -4.24 0.56 18.00 0.00
STA 0.94 1.08 -0.14 -0.40 0.99 0.16 0.69
CFTD -0.10 0.12 -0.22 -3.24 0.69 10.50 0.00
CACL 0.58 1.48 -0.90 -5.34 0.45 28.55 0.00
NPTA -0.17 0.02 -0.19 -3.33 0.68 11.08 0.00
TDTA 1.48 0.68 0.80 3.74 0.62 13.97 0.00
NINW 0.62 0.00 0.62 1.94 0.86 3.77 0.07

The results evidenced that at 95% levels of significance, the significant differences of
financial variables have been found between bankrupt and non-bankrupt companies except
STA and NINW. Thus, the dropping of these two variables STA and NINW makes no
difference in multivariate discriminant analysis. Wilks’ Lambda 0.99 and 0.86 of STA and
NINW respectively indicate that there is no strong difference between bankrupt and non-
bankrupt companies based on these variables. These results have been justified by t-statistics,
f-statistics and p-values of all these variables at 5% significance level except STA and NINW.
This result seems contradict to the findings of Altman (1968) that sales to total assets ratio has
been found one out of five useful ratios as predictor of corporate bankruptcy.

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4.4 Multivariate Discriminant Classification Accuracy
First of all selected companies were classified into bankrupt and non-bankrupt companies
based on negative and positive net worth of observed periods. In other words, the net
worth should be positive to place a company into non-bankrupt. Viewing this way, an
enterprise in classified into bankrupt and non-bankrupt companies. Using SPSS, the
selected twenty five companies have been classified into bankrupt and non-bankrupt
using multivariate discriminate analysis of ten financial variables (ratios).
Table - 3
Accuracy of Discriminant Classification
Table-3 shows the actual group membership, predicted group membership, misclassification of
bankrupt and non-bankrupt companies, type-I error, type II error in both numbers and percent. In
addition, accuracy in classification discriminant classification.

Predicted Group Membership

Total
Bankrupt Non-bankrupt
Actual Group Membership Bankrupt 10 1 11
Non-bankrupt 1 13 14
Total 11 14 25
Type of Error Numbers Correct Percent Correct Percent Error Total
Type I 10 90.9 9.10 100
Type II 13 92.9 7.10 100
Total 23 92 8 100

The initial sample of 11 bankrupt and 14 non-bankrupt companies is examined using

average ratios of selected periods. Since the discriminant coefficients of ten each
variables and the group distribution are obtained from this sample and the high degree of
successful classification is expected. The initial classification is 92% of total sample
correctly. The type-I error proved to be 9.10% while the type II error is 7.10% only. The
results are therefore, encouraging but various upward biases should be kept in mind and
further validation techniques are appropriate.

4.5 Multivariate Discriminant Function

It has been found that original classification was found 92% accurate while discriminating
them on the basis of ten selected financial variables. Based on this original classification,
multivariate discriminant function for future prediction and classification has been developed.
Z = -3.964 - 1.206WCTA + 2.426RETA+ 3.111EBITTA – 1.175MVBV+ 0.581STA
+ 2.492CFTA + 4.07CACL – .033NPTA + 0.41TDTA + 0.025NINW
This model is very useful in predicting bankruptcy of company. Therefore, it will be
necessary to investigate the results presented above and to attempt to extend the model for
more general application. By observing those firms which have been misclassified by the
discriminant model in initial sample, it is concluded that all firms having a Z score of
greater than 0.317 clearly falls into the non-bankrupt group and while those firms having
a Z-score below -0.863 are bankrupt. The area between -0.863 and 0.317 will be defined
the “zone of ignorance” because of the susceptibility to error classification.

4.6 Relative Contribution of Financial Variables

One of the useful techniques to arrive in the final variable profile is to determine the

11
relative contribution of each to variable to the total discriminating power of the function,
and interaction between them. Relevant statistics is observed as scale vector which is
computed by multiplying correspondence element by the square root of the diagonal
elements of the variance and covariance matrix. Since actual variable measurement units
are not all comparable to each other, simple observation of the discriminant coefficient is
misleading. The adjusted coefficient of variable enables to evaluate each variable’s
contribution on a relative basis (Altman, 1968).
Table – 4
Relative Contribution of Financial Variables
Financial Ratios Coefficients Scale Vector Ranking
CACL 4.07 2.50 1
RETA 2.426 1.21 2
EBITTA 3.111 0.43 3
TDTA 0.41 0.27 4
NINW 0.025 0.02 5
NPTA -1.033 -0.18 6
STA -0.581 -0.48 7
CFTD -2.492 -0.49 8
WCTA -1.206 -0.59 9
MVBV -1.175 -0.63 10
Of the ten variables, the large scale vectors of CACL, RETA EBITTA and TDTA indicate
those are the large contributors to the group separation of the discriminant function. CACL
contributes the most and the second highest is the contribution of RETA while MVBA and
WCTA are CFTD the least scale vector indicating the least discrimination power. These
findings are against the findings of Beaver (1966) and Altman (1968).
4.7 Concluding Remarks
The results of profile show that there are differences in the mean ratios of bankrupt and
non-bankrupt firms at least three years prior to bankruptcy. These ratios of bankrupt
companies are found either negative or very poor. However, high difference has been
observed in cash of sales to total assets ratio. These results have been proved statistically
significant at 5% levels of significance. The financial variables of non-bankrupt
companies are found sound in comparison of bankrupt companies of last three years prior
to bankruptcy. A company has been classified as bankrupt company on the basis of
negative net worth otherwise non-bankrupt. This classification is found 92% accurate in
multivariate discriminant analysis of ten financial variables (ratios) and formed a
discriminant function. The type-I error proved to be 9.10% while the type II error is
7.10% only.
Z = -3.964 - 1.206X1 + 2.426X2 + 3.111X3 - 1.175X4 + 0.581X5 + 2.492X6 + 4.07X7 -
033X8 + 0.41X9 + 0.025X10
To determine the relative contribution of each to variable to the total discriminating
power of the discriminant function, current assets to current liabilities ratios have been
found the most important ratio followed by RETA, EBITTA and TDTA while the least
important ratios are CFTD, STA, NPTA and NINW.

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5 Summary and Conclusions
This study mainly aimed to test the predictive power of financial variables (ratios) to
develop multivariate discriminant models in the context of Nepal. Other specific
objectives are: (i) to measure how the financial ratios deteriorate when firms moves to
financial bankruptcy, and (ii) to observe and test the significance differences between
manufacturing companies. The study of predictive power of financial variables using
multivariate discriminant analysis (MDA) is perhaps first in Nepal. This study covers 25
manufacturing companies of Nepal. The necessary financial data and other related
variables were obtained from the official annual reports published by The Nepal Stock
Exchange Ltd and annual reports submitted to Security Board, Nepal by of listed
company up to 2005. Both univariate and multivariate analysis are used to examine the
predictive power of these variables and develop discriminate function of financial ratios
for prediction of corporate bankruptcy for manufacturing enterprises of Nepal.
On the basis of profile and multivariate discriminant analysis, this study concludes that
most of the selected financial ratios of bankrupt and non bankrupt companies observed
very different that ratios of bankrupt manufacturing companies have been found always
lower in three years prior to bankruptcy. However, no significant difference has been
found in case of STA and cash flow between bankrupt and non-bankrupt companies.
While liquidity position of bankrupt companies are also poor. This study shows 92%
accuracy in multivariate discriminant analysis of financial ratios in bankruptcy prediction
context. In case of predictive power of financial ratios, CACL, RETA EBITTA and
TDTA are found large contributors on the basis of higher vector scale. Thus, further study
can be carried out either using more variables, or increasing areas of study or using other
data analysis techniques like artificial neural network, data mining, logit and probit
techniques to enrich research in the areas of bankruptcy prediction context.

13
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 Annexure- 1
LIST OF BANKRUPT AND NON-BANKRUPT COMPANIES

S.No. Name of companies Group Membership

1 Arun Vanaspati Udhyog Limited Bankrupt
2 Birat Shoe Company Ltd. Bankrupt
3 Biratnagar Jute Mills Limited Bankrupt
4 Fleur Himalayan Ltd. Bankrupt
5 Gorakhkali Rubber Udhyog Limited Bankrupt
6 Himal Cement Company Ltd. Bankrupt
7 Juddha Match Factory (Biratnagar) Ltd. Bankrupt
8 Jyoti Spinning Mills Ltd. Bankrupt
9 Khadhya Udhyog Limited Bankrupt
10 Morang Sugar Mills Limited Bankrupt
11 Sri Bhrikuti Pulp and Paper Nepal Ltd. Bankrupt
12 Balaju Yantra Shala Electro Ltd. Nonbankrupt
13 Bottlers Nepal (Terai) Ltd. Nonbankrupt
14 Bottlers Nepal Ltd. Non-bankrupt
15 Butwal Spinning Mills Limited Non-bankrupt
16 Gandaki Brick Factory Limited Non-bankrupt
17 Kacho Chhala Sankalan tatha Bikash Sansthan Non-bankrupt
18 Nepal Banaspati Ghee Udhyog Ltd. Non-bankrupt
19 Nepal Battery Company Limited Non-bankrupt
20 Nepal Bitumen and Barrel Udhyog Ltd. Non-bankrupt
21 Nepal Lever Limited Non-bankrupt
22 Nepal Lube Oil Limited Non-bankrupt
23 Nepal Plywood & Bobbin Co. Ltd. Non-bankrupt
24 Raghupati Jute Mills Limited Non-bankrupt
25 Sri Ram Sugar Mills Ltd. Non-bankrupt

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