An Alternative Proposal based on Organizational Effectiveness and Efficiency Ratios for Forecasting the Financial Status of a Firm

Assessing the insolvency risk is certainly a central issue for economic and financial analysis and of prime importance to financial intermediaries. Despite that, no agreement yet exists. Institutional factors specific to each country, as well as a large variety of other causes which can lead to the failure of a firm, obstruct the way to a general theory. It is instead necessary to deal with this issue, not only because it is central to credit management by banking operators, but also for its overall impact on the economy. This paper analyzes how to forecast the financial status (non-defaulting/defaulting) of a firm. To this aim, alternative procedures were tested on the same data set. Specifically, after analyzing the adequacy of Altman’s Z-score model, (i) it was attempted to solve its well-known limit due to the consideration of the same number of non-defaulting and defaulting firms in the group, (ii) explicative variables related to a firm’s risk of bankruptcy were selected, and finally, (iii) an alternative approach based on panel data was used to divide firms in non-defaulting/defaulting sub-groups. In this way, a considerable reduction of errors in the prediction of a firm’s financial status was progressively obtained.

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