Volume 8, Issue 10, October – 2023 International Journal of Innovative Science and Research Technology

ISSN No:-2456-2165

Predicting Financial distress of Pharmaceutical

Companies in India using Altman Z Score Model
Dr. Vinay Kumar
Associate Professor, Commerce Department
Aryabhatta College
University of Delhi

Abstract:- The present paper aims to measure the II. CONCEPT OF ALTMAN Z SCORE AND
financial distress of top five pharmaceutical companies FINANCIAL DISTRESS
operating in India using Altman’s Z score model. This
model is widely used throughout the world to identify Altman model popularly known as Altman Z score is
financial distress in the company. The classical z score based on multivariate analysis which is used to predict the
model is based on 5 ratios i.e. working capital to total corporate bankruptcy. The model was developed in 1967 by
asset ratio, retained earnings to total asset ratio, EBIT to New York University Professor Edward Altman and got
total asset ratio, market value of equity to total liabilities published in 1968. The original model was updated by
and sales to total asset ratio. The study concluded that Altman few times in coming years. The Z score model is
four companies fall in the Safe zone according to z score. used to predict financial bankruptcy based on different
These companies with average z score of last 5 years are profitability, leverage, solvency and turnover ratios. He had
Sun (9.09) pharma, Dr Reddy (7.61), Cipla (9.097) and developed different models for different kinds of industries
Zydus (4.31). Thus, these companies are financially sound depending upon the type of market in which these companies
and may not face the problem of financial distress. are operating.
Torrent pharma with average z score of 2.52 falls in Grey
zone. Management needs to take immediate steps to The first ever equation developed by him for financial
improve the financial condition to avoid financial distress sector like banks and insurance companies is given below:
in the near future. Z= 1.2 Y1 + 1.4 Y2 +3.3 Y3+ 0.6 Y4 + 1.0 Y5 Where:
Y1= working capital to total asset ratio
Keywords:- Altman z score, Financial distress, Safe zone, Y2 = Retained earnings to total asset ratio
Bankruptcy. Y3= EBIT to total asset ratio
Y4= Market value of equity to total liabilities and
I. INTRODUCTION Y5= Sales to total asset ratio

The financial stability of any company is the key for the The above four factor equation was modified to suit
long-term survival in the market. The capital structure of any manufacturing companies as given below:
company comprises a judicious mix of debt and equity. Debt Z= 6.56 Y1 + 3.26 Y2 +6.72 Y3+ 1.05 Y4
is an important component which helps new companies to
grow faster due to its tax benefit and availability of extra The summary of Altman’s Z score is given below:
money to expand operations. But debt component also poses
the financial threat due to fixed amount of Interest payable Z score Status Implication
irrespective of the performance of the company. Therefore, Above 3 Safe Zone Company will not fail
debt element in the capital structure is one of the important 1.8- 2.99 Grey Zone Company can avoid
reasons for corporate financial distress. Financially weak bankruptcy
companies cannot survive and has to discontinue the Through management
operations thereby destroying the investors wealth. The decisions
situation where company is unable to carry on its operation Less than 1.8 Financial Company cannot avoid
due to its debt is called financial distress. Many large Distress bankruptcy
corporations such as Satyam, Lehman and brothers have
faced the problem of financial distress and ultimately were The Z score obtained through the equation is used to
thrown out of the market. Therefore, each organization needs predict the corporate insolvency. The score below 1.8 is
to keep close eye on the financial stability of in the long run. means company is moving towards bankruptcy. Immediate
actions and strict supervision is required on financial aspect
of the company to avoid possible bankruptcy. Any score
above 3 shows the good financial health of the company. It
means the company may not go bankrupt in the near future.
The z score can be used by the investor for selling or buying
the stock of companies. Investors can exit the stock of the

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Volume 8, Issue 10, October – 2023 International Journal of Innovative Science and Research Technology
ISSN No:-2456-2165
company whose z score falls below 1.8 and buy the stock of returns. The study uses various ratios like quick ratio, cash
the company with z score of 3 or more. The Altman z score ratio, activity ratio and profitability ratios in predicting
succeeded in predicting the global financial crisis of 2008. financial distress. It was found that all the companies were
The median score of companies in a study conducted in 2007 facing decline in the value of these ratios over the years. The
was 1.81 which was very close to the threshold limit of 1.8 profitability ratios were falling in the grey area of z score. All
showing the sings of corporate failure. Therefore, the Altman these companies were having higher loan which kept on
Z score has proved its effectiveness in predicting financial increasing over the years. The financial distress has negative
distress of companies. impact on the performance of stock returns.

Financial distress prediction gained popularity after the Bhunia A and Sarkar R: The study is based on 46
work of Altman (1968). Literal meaning of financial distress private sector pharmaceutical companies listed on recognised
is inability of anyone to generate enough revenue to pay off Indian stock exchange. Multiple discriminant analysis
one’s liabilities. Therefore, the corporate financial distress method is used with sixteen financial ratios including
means inability of the company to meet its obligations. There liquidity, solvency and profitability in analysing the financial
are many causes like excessive investment in unviable distress of these companies. Seven ratios out of sixteen ratios
projects, pricing decisions, financial decisions or even were found to be significant in financial prediction power.
working capital decisions. Financial distress will lead to The MDA model showed more than 85 percent of accuracy
lower credit rating of the company stock and investor will with five-year prior indication of actual financial failure.
also charge higher interest on the loan extended by them. The There is a strong relationship between selected financial
problem of financial distress should be addressed ratios and company health and has strong ability in predicting
immediately otherwise it can turn into the problem of the success and failure of the company in advance.
corporate bankruptcy. Financial distress is a warning signal to
the corporate managers to be careful in the financial matters  Statement of the Problem
and take strong and urgent actions to tackle the issue. Financial distress is a horrifying event a corporation
faces in its life. All the stakeholders investors, creditors,
III. REVIEW OF LITERATURE bankers, workers are concerned about the health of the
company because of their vested interest. Thus, it is the
Many studies have been conducted in India and abroad responsibility of the management to take all necessary steps
to measure the financial distress of the companies. All these to prevent the problem of financial distress in any company.
studies have used different ratios like liquidity ratio, margin
ratio, solvency ratios etc. and are mostly based on different  Objectives of the study
variants of Altman z score model. The finding of some of the Following are the objectives of the study:
studies are discussed here:  To predict the financial distress of the of the selected
pharmaceutical companies in India using Altman Z score
Finch et. al (2008): The study tries to analyses the model
impact of good governance practices in avoiding the problem  To compare the Z score of selected pharmaceutical
of financial distress. It was found that good governance companies in India
practices like introducing higher number of independent
directors than the inside director in the board, larger IV. RESEARCH DESIGN
ownership stake of inside directors have positive impact in
avoiding financial distress.  Sample size and data
The present study analyses the corporate financial
Elijelly (2004) conducted a study in the paper titled distress of top five large cap pharmaceutical companies listed
“Liquidity – profitability trade-off: An empirical on BSE and operating in India for the period 2018-2023.
investigation in an emerging market”. The study was These five companies constitute more than 75% of total
conducted on joint stock companies based in Saudi Arabia pharmaceutical production in India. These companies are
found negative relationship between liquidity levels and selected on the basis of their market capitalisation in the year
profitability of the firm. 2023. Thus, health of these companies can depict the overall
health of the pharmaceutical industry in India.
Celli, M. (2015): The study is based on 102 industrial
companies quoted on Italian stock exchange for the period of The present study is based on secondary data. The data
1995-2013. Shares of 51 companies were delisted from the of these pharma companies for 5 years viz 2018-2023 have
stock exchanges due to insolvency during that period. The been taken from CMIE prowess data, moneycontrol.com and
study found that Altman Z score model was effective in published annual reports of these companies.
predicting financial insolvency of the companies in Italian
context.  Selection of variables
The Z score is based on five ratios accounting ratios.
BMB Akbar et. al; The study is based on sample of 7 These ratios and their relationship with the financial position
pharmaceutical companies listed on Indonesian stock has been explained below:
exchange. The study uses panel data regression in predicting
the impact of financial distress of the company on stock

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Volume 8, Issue 10, October – 2023 International Journal of Innovative Science and Research Technology
ISSN No:-2456-2165
 Y1= Working Capital/Total Asset ratio (WC/TA*100)  Y5= Sales to Total Asset ratio (S/TA) ratio shows the
shows efficiency of the company in using its liquid assets efficiency of the company in utilising the assets to create
or working capital. Working capital is difference of the sales. The ratio has positive impact on the z score.
current assets and current liabilities of the company. The
working capital requirement differ across companies. The V. LIMITATIONS OF THE STUDY
higher working capital ratio has positive impact on the z
score. The present study contributes immensely to the exiting
 Y2= Retained Earnings to Total Asset ratio (RE/TA*100) literature of the corporate financial distress with special
shows the ability of the company in utilising the retained reference to the pharmaceutical industry in India. But the
earning to finance its operations. Generally, large and study analyses the financial distress of only five large cap
stable companies have retained earnings at their disposal. companies operating in India for a period of 2018-2023. The
The higher retained earing ratio has positive impact on finding of the present research may not be applicable to small
the z score. and medium cap pharmaceutical companies in India. The
 Y3= EBIT to Total asset ratio (EBIT/TA*100) is a time period could have been extended for better inferences.
profitability ratio. The ratio shows the efficiency of the The study is limited to the companies operating in India.
company in utilising the assets to create operating profit.
EBIT stands for earning before interest, tax and dividend VI. EMPIRICAL FINDING AND DISCUSSIONS
payments. It has positive impact on the z score.
 Y4= Market value of Equity to book value of Liabilities Present section deals with the Z score calculations of
(MVE/L*100) ratio is opposite of debt-to-equity ratio. selected pharmaceutical companies using five financial ratios
The ratio has negative impact on the z score. from financial year 2018-19 to 2022-23.

Table 1 Present section deals with the Z score calculations of selected pharmaceutical companies using five financial ratios
from financial year 2018-19 to 2022-23.
Year 2018-19 2019-20 2020-21 2021-22 2022-23 Mean Z score
Company
Sun Pharma 4.855647 7.452575 9.27722 13.02 10.88437 9.097962
Safe Safe Safe Safe Safe Safe
Dr Reddy 5.579376 9.038364 7.74137 6.841471 8.89311 7.618738
Safe Safe Safe Safe Safe Safe
Cipla 4.855647 7.452575 9.27722 13.02 10.88437 9.097962
Safe Safe Safe Safe Safe Safe
Torrent 2.456586 2.548492 2.494459 2.594298 2.550022 2.528771
Grey Grey Grey Grey Grey Grey
Zydus 2.782501 3.67755 4.470805 4.323485 6.336888 4.318246
Grey Safe Safe Safe Safe Safe
Source: calculated on the basis of data taken from annual reports of these companies

The Z score of selected pharmaceutical companies is Torrent Pharma scores less than benchmark score in all
presented in the table above also shows the financial status of selected years. The mean score of Torrent pharma is also 2.52
the company for that respective year. The Sun Pharma the which falls in the category of Grey company. Therefore, the
biggest pharmaceutical company is above 3 score in all the management of Torrent pharma need to take urgent and
years thereby given the status of Safe company. The mean z effective steps to prevent the companies slipping in the
score of Sun Pharma is 9.097 which is more than three times category of distress company. Investors also need to be alert
of safety score. Thus, Sun pharma is financially strong as per and keep constant vigilance on the working and result of the
z score calculations. Similarly, the mean z score of Dr. Reddy management.
is more than two times of the benchmark z score of 3
therefore falling in the Safe category. Dr. Reddy also has The Zydus pharma is also falling in the category of Safe
more than benchmark score of 3 in all the years. Therefore, companies in all years except the year 2019-19. The z score
Dr. Reddy is also financially sound company in all the for the year 2018-19 is 2.78 which falls in the Grey zone. The
selected years. The Cipla pharmaceutical is also above the mean score of Zydus pharma is 4.31 which is above the safe
threshold limit of 3 in all the years with mean score of 9.09. zone score. Therefore, Zydus pharma is also considered as
financially strong company based on z score calculations.

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Volume 8, Issue 10, October – 2023 International Journal of Innovative Science and Research Technology
ISSN No:-2456-2165
14
Yearly Z score
12

10

0
Sun Dr Reddy Cipla Torrent Zydus
Pharma 2018-19 2019-20 2020-21 2021-22 2022-23

Fig 1 Graphical presentation of Z score of selected pharmaceutical companies in India.

The bar diagram shows the z score of selected REFERENCES

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Sun pharma, Dr. Reddy, Cipla and Zydus falls in the healthy
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Torrent pharmaceutical company falls in Grey zone. It means
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company may face bankruptcy problem in near future.

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