Profitability Ratio As A Tool For Bankruptcy Prediction Content File PDF
Profitability Ratio As A Tool For Bankruptcy Prediction Content File PDF
Profitability Ratio As A Tool For Bankruptcy Prediction Content File PDF
Location: Romania
Author(s): Daniel Brîndecsu-Olariu
Title: Profitability Ratio as a Tool for Bankruptcy Prediction
Profitability Ratio as a Tool for Bankruptcy Prediction
Issue: 11/2016
Citation Daniel Brîndecsu-Olariu. "Profitability Ratio as a Tool for Bankruptcy Prediction". SEA –
style: Practical Application of Science 11:369-372.
https://www.ceeol.com/search/article-detail?id=740237
CEEOL copyright 2023
Keywords
Corporate finance,
Risk,
Failure,
Financial ratio,
Financial analysis,
Classification accuracy
JEL Classification
G32, G33, M21
Abstract
The current study evaluates the potential of the profitability ratio in predicting corporate
bankruptcy. The research is focused on Romanian companies, with the targeted event being represented by
the manifestation of bankruptcy 2 years after the date of the financial statements of reference. All tests
were conducted over 2 paired samples of 1176 Romanian companies. The methodology employed in
evaluating the potential of the profitability ratio was based on the Area Under the ROC Curve (0.663)
and the general accuracy ensured by the ratio (62.6% out-of-sample accuracy). The results confirm the
practical utility of the profitability ratio in the prediction of bankruptcy and thus validate the need for
further research focused on developing a methodology of analysis.
369
370
paired, the „by chance” accuracy is 50% (by half of the Romanian companies) involve the
classifying all 318 companies as bankrupt, the registration of losses. Such losses diminish the net
analyst would be correct in 50% of the cases). The cash flows, with negative impact on the payment
profitability ratio will be considered a useful capacity of the company. From the perspective of
classifier if it would allow for an out-of-sample the balance sheet, losses diminish the equity and
general accuracy at least 25% higher than the „by thus lead to reductions of the working capital,
chance” accuracy (Chung, K., Tan, S., Holdsworth, autonomy ratio and solvency ratio.
D., 2008). The research proves the potential of the
profitability ratio in the prediction of bankruptcy
3. Results and underlines the need for determining an optimal
Within both samples, more than 50% of the cut-off value through research over the entire
companies registered negative profitability ratio. population (or a sample with the same structure).
This aspect is in accordance with the statistics over
the entire population from Timis County. Reference list
The Area Under the ROC Curve specific to the [1] Brîndescu – Olariu, D. (2016). Solvency
profitability ratio over the 2010 paired sample was ratio as a tool for bankruptcy prediction, paper
of 0.663, which suggests a relatively poor, but valid submited for publication.
classification accuracy (Tazhibi, Bashardoost and [2] Brîndescu – Olariu, D. (2015a). The
Ahmadi, 2011). The dynamics of the AUC shows potential of the debt ratio in the prediction of
stability in the classification performance of the bankruptcy, Journal of Public Administration,
profitability ratio over the 2009 – 2010 period Finance and Law, Special Issue 2, pp. 37-45.
(figure 1). [3] Brîndescu – Olariu, D. (2015b). Utilitatea
Based on the coordinating points of the ROC Curve ratei autonomiei financiare globale în evaluarea
for 2010, an optimal cut-off value was determined riscului de insolvență, Management Intercultural,
(profitability ratio = -9.92%). By classifying all the XVII(34), pp.321-329.
companies from the 2010 paired sample that [4] Brîndescu – Olariu, D.(2014a). Labor
registered profitability ratios lower than -9.92% as productivity as a factor for bankruptcy prediction,
bankrupt and all the companies from the 2010 SEA – Practical Application of Science, II, Issue 4
paired sample that registered profitability ratios (6).
higher than -9.92% as non-bankrupt, the general [5] Brîndescu – Olariu, D. (2014b). The
classification accuracy would be of 63.3% (as potential of the equity working capital in the
shown in figure 2). prediction of bankruptcy, Management
Thus, the in-sample general accuracy is positioned Intercultural, XVI (31), 2014, pp. 25-32.
above the 62.5% benchmark. Out of sample [6] Chung, K., Tan, S., Holdsworth, D.
accuracy tests were performed over the 2009 paired (2008). Inprofitability prediction model using
sample, using the cut-off value from 2010. The multivariate discriminant analysis and artificila
general accuracy over the 2009 sample was of neural network for the finance industry in New
62.6% (above the 62.5% benchmark as well). Zealand, International journal of business and
management, 39 (1), pp.19-29.
Conclusions [7] van Erkel, A., Pattynama, P. (1998).
The Areas Under the ROC Curve for both paired Receiver operating characteristic (ROC) analysis:
samples show that the profitability ratio can be Basic principles and applications in radiology,
used as a tool for the assessment of the bankruptcy European Journal of Radiology, 27 (2), pp. 88-94.
risk. This conclusion is also sustained by an out-of- [8] Faragei, D, Reiser, B (2002). Estimation of
sample general classification accuracy of 62.6%. the area under the ROC curve. Statistics in
The results of the study confirm that companies medicine, 21, pp. 3093-3106.
with high profitability ratios show lower [9] Hanley, J.A., McNeil, B.J. (1982). The
bankruptcy risks. High profitability ratios increase meaning and use of the area under a receiver
net cash flows, with positive effects on the payment operating characteristic (ROC) curve, Radiology,
capacity of the company. High levels of the 143 (1), pp.29-36.
profitability ratio are a basis for the generation of [10] Skalska, H., Freylich, V. (2006). Web-
large profits, which automatically increase of the Bootstrap Estimate of Area Under ROC Curve,
equity of the company (and remain part of the Australian Journal of Statistics, 35 (2&3), pp. 325-
equity until a decision of distribution is taken). The 330.
increase of equity sustains an increase of the [11] Tazhibi, M, Bashardoost N, Ahmadi, M
working capital, a factor that was proven by (2011). Kernel Smoothing For ROC Curve And
researches from all over the world to be closely Estimation For Thyroid Stimulating Hormone,
related to the bankruptcy risk (negative International Journal of Public Health Research,
correlation). On the other hand, negative Special Issue 2011, pp. 239-242.
profitability ratios (which characterize more than
371
Figure 1. Area Under the ROC Curve over the 2 paired samples – profitability ratio
Figure 2. General accuracy with optimal cut-off values for each year
372