Tuesday, February 1, 2011

Use of Bankruptcy Prediction Models as an Auditing Tool

One of the best-known models for predicting corporate financial distress is the Altman’s Z-Score model (Altman, 1968, 1983, 1993). This model is constructed using linear relationship of financial ratios weighted by predefined coefficients. Initially the model was developed to assess the bankruptcy of publicly held manufacturers, but later it was re-estimated for private manufacturing, non-manufacturing and service companies. Therefore, the model is three folds: Z-model (original model); Z’-model (private firm model); Z’’-model (nonmanufacturing firm model). Eventually a firm is categorized based on its Z-score as non-bankrupt, bankrupt or gray area in each of the aforesaid three Z-score models.

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