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An empirical study of the usefulness of accounting ratios to describe levels of insolvency risk

Lincoln, Mervyn George ( 1982)

This study aims to add a new dimension to research in Australia on the use of accounting ratios to predict corporate failure. Previous studies have used the statistical technique of discriminant analysis to derive models for predicting whether a firm will or will not fail. This study will use the same statistical technique but with three differences: (a) The ratios to be used in the discriminant analysis are selected by a method which ensured that no arbitrary limit is placed on their number. (b) Because the significance of accounting ratios can vary from industry to industry, four industries are separately analysed: manufacturing, retail, property, and finance. (c) The statistical probabilities yielded by the analysis are used to measure a firm’s current level of insolvency risk. The extra dimension is added by interpreting the characteristic patterns of insolvency risk which emerge: an analysis of the factors causing the differences in these patterns throws new light on the causes, symptoms, and remedies of financial distress.