Presentation By SHREYA BHOTICA

01 Financial distress

02 Financial distress models

Blum marc’s failing

03 company model

04 L.C. Gupta model

 Financial Distress
§ Financial distress is a condition in which a company or individual cannot
generate revenue or income because it is unable to meet or cannot pay its
financial obligations.
§ This is generally due to high fixed costs, illiquid assets, or revenues
sensitive to economic downturns.
§ Financial distress is usually the last step before bankruptcy.

§ In order to remedy the situation, a company or individual may consider

options like restructuring debt or cutting back on costs.
 Financial Distress Models
§ BLUM MARC’S FAILING COMPANY MODEL
§ L.C. GUPTA MODEL
§ BEAVER MODEL
§ WILCOX MODEL
§ ALTMAN’S Z SCORE MODEL
§ DEAKIN’S MODEL
§ MEYER AND PIFER’S MODEL
§ OHLSON’S LOGIT MODEL
 BLUM MARC’S FAILING COMPANY MODEL
§ Developed to assess the probability of business failures.
§ Failure was defined as an inability to pay debts as they become
due, entrance into the bankruptcy or explicit agreement with
creditors to reduce debts
§ Discriminant Analysis was applied to a paired sample of 115
failed and 115 non-failed firms.
§ Sampling was based on four criteria, utilised in following order –
industry, sales, employees, and fiscal year.
§ Source of data was balance sheet, income statement and stock
market prices of all the companies.
BLUM MARC’S FAILING COMPANY MODEL
Marc treated the business firm as reservoir of financial resources
and described its probability of failure in terms of expected flow of
these resources. According to this cash flow framework, other
things being equal, the probability of failure is more likely -
§ The smaller the reservoir
§ The smaller the inflow of resources from operations in both the
short run and long run
§ Larger the claims on resources by creditors
§ Greater the outflow of resources required by operations of
business
§ The more ‘failure prone’ the industry location of the firm’s
business activities are expected to be.
 BLUM MARC’S FAILING COMPANY MODEL
§ The model included 12 variables mainly focusing on liquidity,
profitability and variability in the cash flow framework.
§ The accuracy of the failing company model in distinguishing
failing firms and non-failing firms was tested using discriminant
analysis for computing an index and a cut off point on the index
§ FCM Model Prediction result :
• The model predicted the corporate failure with an accuracy
of approximately 94%, when failure occurred with in one
year from the date of prediction.
• Accuracy of 80% for failure two years into the future.
• Accuracy of 70% for failure three, four and five years distant.
 L.C. GUPTA MODEL
§ L.C. Gupta made an attempt to examine survival strength of the
company derived from the concept of marginal firms.
§ Sampling design :
• 41 cotton textile companies (20 sick and 21 non-sick)
• 39 non-textile companies (18 sick and 21 non-sick)
The matching was done on the basis of product or products
manufactured, age and size measured in terms of paid-up capital,
assets and sales.
§ Period of study : 1962 – 1974
§ Total ratios analysed : 63
 L.C. GUPTA MODEL
1. Take a sample of Sick and Non-Sick companies.
2. Arrange them in the ascending or descending order by the
magnitude of the ratio.
3. Select a cut-off point carefully which will divide the array into
two classes with a minimum possible number of
misclassification.
4. Compute the percentage of classification error.
5. The ratio which shows the least “ percentage classification error”
at the earliest possible time is deemed to have the highest
predictive power.
 L.C. GUPTA MODEL
The model recommended a combination of the following four
major ratios in order to minimise the classification error rate:
𝑬𝑩𝑫𝑰𝑻
§ X1 =
𝑺𝒂𝒍𝒆𝒔
𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒏𝒈 𝑪𝒂𝒔𝒉 𝑭𝒍𝒐𝒘
§ X2 =
𝑺𝒂𝒍𝒆𝒔
𝑬𝑩𝑫𝑰𝑻
§ X3 =
𝑻𝒐𝒕𝒂𝒍 𝑨𝒔𝒔𝒆𝒕
𝑬𝑩𝑫𝑰𝑻
§ X4 =
𝑰𝒏𝒕𝒆𝒓𝒆𝒔𝒕+𝟎.𝟐𝟓 𝑫𝒆𝒃𝒕
 L.C. GUPTA MODEL OBSERVATIONS
§ The ratios relating to net worth were found to be worst
predictor of bankruptcy among profitability ratios.

§ Among balance sheet ratios, the solvency ratios were more

reliable indicators of strength than any liquidity ratios.

§ The model also observed that companies with inadequate

equity base are more sickness prone.
Thank You
Any Questions ??