3.

mezinárodní konference Řízení a modelování finančních rizik Ostrava

VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

Analysis and estimate of the enterprises bankruptcy

risk
Tatsiana N. Rybak1

Abstract
The amount of enterprises, which are undergoing bankruptcy, is increasing in the Republic of
Belarus. Therefore, the problem of bankruptcy risk assessment is quite topical. We formed the
system of bankruptcy criteria and indicators. By comparing actual indicators and standard
values the bankruptcy risk of an enterprise can be evaluated. For prediction of domestic
industrial enterprises bankruptcy risk we worked out a general indicator using the statistics
method of discriminant analysis. List of tests for the expert bankruptcy risk evaluation was
compiled. Formal and informal symptoms of bankruptcy are assessed by grades. Methods of
analysis and estimate of the enterprises bankruptcy risk that we worked out are being used by
the Ministry of Economics of Belarus.

Key words
Bankruptcy risk, criteria, indicators, discriminant function, tests

1 Theoretical and methodological basis of analysis and estimate of

the enterprises bankruptcy risk
1.1 The essence and content of the bankruptcy risk
Bankruptcy risk is a possibility of anticipated legal bankruptcy procedure, followed by
unfavourable financial consequences such as loss of resources or expecting income.
Bankruptcy risk is not equal to probable bankruptcy. The latter means the measure of
appearance of risk event.
Bankruptcy risk takes place at all stages of the company’s life cycle. Its appearance is an
objective inevitability of manager’s activities which is conditioned by vagueness of
surroundings and insufficiency of company’s resources.
We distinguish the following levels of bankruptcy risk:
• primary risk level. This risk is not valued and consequently high enough because
managers are unready to foresee risk event;
• estimated risk level. This risk is analysed and lower because of readiness of the
managers to appeared risk event;
• final (acceptable) risk level. The measures for reducing of the primary risk level are
worked out and implemented.
Detailed analysis of bankruptcy risk and the elaboration of measures which neutralize its
negative consequences allows to make risk decisions.

1
Tatsiana N. Rybak, Associate professor, PhD in Economic Sciences,Belarusian State Economic
University, 26, Partizanski Av., Minsk, 220070, Republic of Belarus, Phone: ++ 375296564618; Fax:
++ 375172117576, e-mail: carina96@tut.by

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VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

Figure 1: The levels of bankruptcy risk

I II III
risk level Risk analysis risk level Risk-reducing risk level
and valuation measures

Primary Estimated Final risk

level risk

1.2 Legal foundation of the analysis and estimate of the enterprises bankruptcy risk in
the Republic of Belarus
In Belarus the amount of enterprises, which are undergoing bankruptcy, is increasing (from
81 in 1998 to 1360 in 2005). In early March, 2006, there were 1070 unfinished bankruptcy
cases. 92,5 percent of them were filed against private companies and individual businesses
[7].
Legal regulation of bankruptcy in Belarus is provided by legislative framework which
consists of the principal Law on Economic Insolvency (Bankruptcy) and more than ninety
elements of law with amendments, notes and explanations to it. However, the bankruptcy
procedure has not been provided with the analytical backup. Its methodical and organisational
aspects are being developed.
The Ministry of Finance, the Ministry of Economics and the Ministry of Statistics and
Analysis of the Republic of Belarus passed the instruction on analysis and control for
financial position and solvency of individual businesses in 2004. The main object of this
document is evaluation of enterprises solvency using information from financial statements.
The instruction on analysis and control for financial position and solvency of legal entities
is required to be improved by including methods of bankruptcy risk assessment.

2 Methods of analysis and estimate of the enterprises bankruptcy

risk
2.1 The system of bankruptcy criteria and indicators
Economic aspects of enterprise activity play a decisive role for establishing the fact of
bankruptcy. Therefore, it is important to reveal criteria of enterprises’ crisis state. These
criteria discover the essence of changes taking place in the enterprise activity from the point
of view of the bankruptcy risk.
Unequivocal and generally acknowledged criteria are non-existent. We summarized works
on prediction of bankruptcy risk by foreign and domestic economists in general and analyzed
the activity of enterprises close to bankruptcy. As a result, we have systemized bankruptcy
criteria for the Belarusian enterprises which includes the following groups of criteria:
• financial criteria (unprofitable business, presence of overdue liabilities, total liabilities
exceeding total assets, inability to pay off current liabilities by current assets, lack of
working capital, presence of overdue accounts receivable, decreasing of market value
of shares and securities);

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VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

• production criteria (presence of extra raw materials and finished products, insufficient
diversification of enterprise activity, violation of a steady rhythm of enterprise
activity, lowering level of production power usage);
• investment criteria (short-sighted investment policy, inefficient long-term contracts);
• marketing criteria (loss of permanent clients and suppliers, unfavourable changes in
the orders portfolio);
• others (labour conflicts, participation in dubious trials, etc.).

Furthermore, we have chosen absolute and relative indicators for financial criteria evaluation
(table 1).

Bankruptcy criteria Absolute indicators Relative indicators

Unprofitable business Gross profit Profit margin

Net profit Net profit ratio
Presence of overdue Overdue liabilities Overdue debt ratio
liabilities
Total liabilities exceeding Net assets Debt ratio
total assets
Inability to pay off current Net cash flow Current ratio
liabilities by currents assets
Lack of working capital Working capital Ratio of working capital
provision
Presence of overdue Overdue accounts Unit weight of overdue
accounts receivable receivable accounts receivable in sum
total of accounts receivable
Decreasing of market value Market cost of shares Income per share
of shares and securities and securities
Table 1: The system of indicators for analysis the enterprises bankruptcy risk

Absolute indicators are used for the effective discovery of bankruptcy criteria, but they are
not compared at different time in inflation conditions. Relative indicators are calculated at the
beginning and the end of some financial years and compared with the standards.
We calculated average meanings of indicators using financial statistics data of bankrupts of
different branches of economics for a number of reporting periods. Based on the received
results we substantiated standard values of some ratios which were differentiated depending
on the branches of economics. For instance, standard values of current ratio and ratio of
working capital provision are shown in table 2.
Reference to actual results and standard values compared, the corporate financial position
can be evaluated.

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VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

Branches of economics Current ratio Ratio of working capital provision

Industry 1.7 0.3
Agriculture 1.5 0.2
Transport 1.15 0.15
Communication 1.1 0.15
Building 1.2 0.15
Trade and public cafering 1.0 0.10
Logistics 1.1 0.15
Utility service 1.1 0.10
Science 1.15 0.20
Table 2: Standard values of current ratio and ratio of working capital provision

For discovery of production, investing, marketing and other criteria the analysis of
manufacture and sales of products, investment projects and marketing activities are conducted
using not only financial statements, but also corporate accounting and management
documention.
2.2 The discriminant function for bankruptcy risk prediction
The discriminant functions for bankruptcy risk prediction were offered by Altman [1],
Taffler [5], Beaver [3] and others. But they are not acceptable for the Belarusian enterprises
because of different conditions of management in highly developed countries, as compared to
this country. Besides, the mentioned functions did not take into consideration sectoral
peculiarities of enterprises activity.
For prediction of domestic industrial enterprises bankruptcy risk, we have worked out a
general indicator using the statistics method of discriminant analysis.
In general, discriminant analysis derives the linear combination of dicriminanting
(independent) variables from discriminant function that takes the following form:

Z = β1x1 + β2x2 + ... + βnxn + c, (1)

where Z – discriminant score, β1, β2, ... βn - discriminant coefficients, x1, x2, ... xn –
discriminanting variables, c – constant.
The main purpose of discriminant analysis is to predict group membership based on a
linear combination of the interval variables.
We opted two groups from the totality of 130 industrial enterprises. The first one included
enterprises which became bankrupts. The second one included those enterprises which had
stable financial position. Then we studied the difference between financial indexes of
bankrupt and non-bankrupt enterprises. The data comprised the annual financial statements of
selected Belarusian bankrupt enterprises and their non-bankrupt mates. Each failure occured
between 1999 and 2005. The selections consisted mainly of small and medium-sized
enterprises. The lack of larger enterprises was explained by the fact that the number of
enteprises which close to bankrupt was very small in Belarus.
The set of variables for the discriminant function was chosen using backward elimination.
At first a lot of variables were included in the model. Then the indicators failing to sigficantly
contribute to the process of enterprises grouping were rejected at each step.
Coefficients and constant of discrimination have been calculated using methods of
discriminant analysis.
The equation of discriminant function which we worked out is the following:

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VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

Z = 28,8x1 -11,6x2 – 16,7x3 + 51,6x4, (2)

where x1 – specific gravity of overdue accounts receivable in sum total of accounts

receivable; x2 – current ratio; x3 - debt ratio; x4 – overdue debt ratio.
The probability of bankruptcy is predicted according to the assessment of the discriminant
function. If Z ≥ 9,4 the probability of industrial enterprise bankruptcy is high. If Z < 9,4 the
probability of its bankruptcy is low.
2.3 List of tests for the expert bankruptcy risk evaluation
List of tests for the expert bankruptcy risk evaluation have been compiled. Employees of
an enterprise are interviewed. Style and basic principles of management, corporate
organisational structure, personnel policy, book-keeping, preparation of financial and
management statements are studied. Formal and informal symptoms of bankruptcy, such as
authoritarian style of management, lack of internal auditing, unqualified cashmanagement,
forging of accounting documents and others, are revealed and assessed by grades. The level
of probale bankruptcy (low, average or high) is determined by the sum of grades.

3 Conclusion
Methods of analysis and estimate of the enterprises bankruptcy risk such as the system of
bankruptcy criteria and indicators, the discriminant function and list of tests that we worked
out are being used by the Ministry of Economics of the Republic of Belarus for monitoring of
enterprises’ financial position. Besides, they can be used by anticrisis managers while
deciding on measures for companies sanation and by auditors for making expert opinion on
bankruptcy probability of enterprises being audited.

Reference
[1] ALTMAN, E. Financial ratios, discriminant analysis and the prediction of corporate
bankruptcy. The Journal of Finance, 1968, vol. 23, pp. 589-609.
[2] ASQUITH, P., GERTHER, R., SCHARFSTEIN D. Anatomy of Financial Distress: an
Examination of Junk Bonds Issues. QJE, 1994, vol. 109, pp. 625-658.
[3] BEAVER, W. Financial ratios as predictors of failure. Journal of Accounting Research,
1966, vol. 5, pp. 71-111.
[4] RYBAK, T. Criteria and indicators of the enterprises bankruptcy probability. Accounting
and analysis, 2005, Vol. 107, No. 11, pp. 9-12.
[5] Handbook for credit management. Infra-M, Moscow, 1996
[6] The National Centre of Legal Information of the Republic of Belarus. Law of the Republic of
Belarus on Economic Insolvency (Bankruptcy), July, 18 2000 № 423-З,
[7] http://ncpi.gov.by/eng/legal/V19100826.htm, [Accessed 30.10.2003]
[8] Sparta Blog Bankruptcy: Statistics, http://blog.sparta.by/?p=10, [Accessed 25.03.2006]

Summary
The amount of enterprises, which are undergoing bankruptcy, is increasing in the Republic
of Belarus. Timely risk assessment can foresee and prevent the legal bankruptcy of
enterprises.

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3. mezinárodní konference Řízení a modelování finančních rizik Ostrava
VŠB-TU Ostrava, Ekonomická fakulta, katedra Financí 6.-7. září 2006

We formed the system of bankruptcy criteria and indicators. By comparing actual

indicators and standard values the bankruptcy risk of an enterprise can be evaluated. For
prediction of domestic industrial enterprises bankruptcy risk, we worked out a general
indicator using the statistics method of discriminant analysis. List of tests for the expert
bankruptcy risk evaluation was compiled. Formal and informal symptoms of bankruptcy are
assessed by grades. The level of the bankruptcy probability is determined by the sum of
grades.
Methods of analysis and estimate of the enterprises bankruptcy risk that we worked out are
being used by the Ministry of Economics of Belarus.

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