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Predicting Private Companies

Failure in the Sudan
a
Abuzar M. A. Eljelly DBA & Ilham Hassan F. Mansour
b
MSC (Management)
a
Department of Business Administration , College
of Administrative Sciences, King Saud University ,
Riyadh, 11451, K.S.A
b
School of Management Studies, University of
Khartoum , P. O. Box 321, Khartoum, Sudan
Published online: 12 Oct 2008.
To cite this article: Abuzar M. A. Eljelly DBA & Ilham Hassan F. Mansour MSC
(Management) (2001) Predicting Private Companies Failure in the Sudan, Journal of
African Business, 2:2, 23-43, DOI: 10.1300/J156v02n02_03
To link to this article: http://dx.doi.org/10.1300/J156v02n02_03
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Predicting Private Companies Failure
in the Sudan
Abuzar M. A. Eljelly
Ilham Hassan F. Mansour
ABSTRACT. This paper applies failure prediction techniques to a

sample of private companies in the Sudan, an African Less Developed
Country (LDC). As a first step, the study uses profile analysis and
dichotomous classification techniques to test the ability of univariate
models in predicting failure in a simple and less complex economic
environment. Next, the study replicates Altman Multiple Discriminant
Analysis (MDA) to the sample but achieved low failure prediction rates
relative to those obtained in the developed and developing economies.
The study then re-estimates Altman original model parameters with a
significant improvement in failure prediction rates. Finally, using a
stepwise MDA methodology, the study develops a three-variable model
that improves upon Altman replicated and re-estimated models in classi-
fying companies into failed and nonfailed categories. [Article copies avail-
able for a fee from The Haworth Document Delivery Service: 1-800-342-9678.
E-mail address: <getinfo@haworthpressinc.com> Website: <http://www.Haworth
Press.com> E 2001 by The Haworth Press, Inc. All rights reserved.]
KEYWORDS. Business failure, profile, dichotomous, MDA, Less De-

veloped Country (LDC)
INTRODUCTION
Business failure has been a subject of concern for many parties, including
those who have direct interest in the business such as shareholders, em-
Abuzar M. A. Eljelly, DBA, is Assistant Professor of Finance, Department of

Business Administration, College of Administrative Sciences, King Saud University,
Riyadh, 11451, K.S.A. (E-mail: Aeljelly@ksu.edu.sa). Ilham Hassan F. Mansour,
MSC (Management), is associated with the School of Management Studies, Univer-
sity of Khartoum, P. O. Box 321, Khartoum, Sudan.
Journal of African Business, Vol. 2(2) 2001
E 2001 by The Haworth Press, Inc. All rights reserved. 23
24 JOURNAL OF AFRICAN BUSINESS
ployees and creditors and those who are less directly related to business such
as regulators and governments. All these parties and others have indulged in
continuous pursuit of building models that are meant to help predicting

failure and thus alleviating its consequences on those groups and on the
society at large.
Although the studies that have sought to predict failure go back to the
1960’s, where ratio analysis was the prime tool, the quest for an optimal
model that achieves high success rate in predicting failure never abated. The
prime reason has been that the developed models were not parsimonious, in
the sense that one model could not fit all failure situations and cases. Howev-
er, most of the existing studies have been made in developed and highly
developing economies environment. Few studies have been made in less
developed economies where the economic climate may affect the success of
the models developed initially in highly developed economies.
Thus, it would be a worthwhile addition to the existing literature to ex-
amine how the most successful models originated in developed economy
flare in less developed ones, and whether the models need modification in
order to fit the latter. Hence, this study attempts to apply existing failure
prediction models on a sample of private companies in the Sudan, a less
developed country, and examines their performance in this economic climate.
Based on the ensuing evaluation of the results the study will attempt to
develop a model that aims to improve upon the predictive ability of the
existing models, given economic and business environment in the Sudan.
LITERATURE REVIEW
Failure prediction studies can be broadly classified into two groups; uni-
variate and multivariate group. Initiated by Beaver (1966), Tamari (1966) and
Wilcox (1971) the univariate models were the earlier to develop, and repre-
sented serious efforts to address the issue of predicting failure. The objective
of those earlier attempts was to derive failure indicators by observing the
behavior of financial ratios. The profile analysis relied on means of financial
ratios while dichotomous classification techniques used financial ratios rather
than their means. However, those models suffer from a major shortcoming
that they apt to use popular ratios that are subject to manipulation and they
could result in conflicting classifications (Zavgren, 1983).
Those shortcomings together with the notion that one ratio can not capture
enough information to make it qualified for failure classification, had put
impetus on using more than one ratio in failure prediction. Tamari (1966)
index of risk, which is composed of many relevant financial ratios, represents
an earlier attempt in that direction. Although the Multiple Discriminant Anal-
ysis (MDA) was in use since the 1930’s in many different fields of studies
Abuzar M. A. Eljelly and Ilham Hassan F. Mansour 25
(Huberty, 1994), Altman adoption of the model in 1968 and the subsequent
studies that followed its tracks made it the most renowned and favorite
among the failure prediction models. The model links a set of independent
variables to a dependent variable that can take discrete values. The MDA
enables one to distinguish between two or more groups of observations on the
basis of an optimal set of discriminating variables. As such the model was
successful in classifying the sample of firms used by Altman into bankrupt
and nonbankrupt companies.
The Altman study was replicated by Deakin (1972) with the exception that
financial ratios used by Beaver were adopted instead of the ones suggested by
Altman. The study showed a significant improvement over the results re-
ported by Altman. A study by Altman and Spivack (1983) shows that there is
no difference between Zeta model (variant of the original Z model) and value
line approach that combines mathematical and human judgement systems.
Dambolena and Khoury (1980) took care of the instability of ratios presumed
to be associated with failed firms. The study achieved limited success over
years far from the event of bankruptcy. However, Zavgren (1983) argues that
the Altman model variables and coefficients are sample specific. Studies by
Blum (1974), Moyer (1977) further showed that the model is sensitive to the
time period used to develop the model, the size of the firm, or both.
Another group of prediction models came into existence to overcome the
restrictive assumptions that must hold in order for Altman model to achieve
valid and unquestionable results (Joy and Tollefson, 1975). These assump-
tions include random sampling, independent population for each of the
groups and absence of cross-correlation among the chosen variables. These
studies used Probit and logit techniques instead of the multiple discriminant
analysis. Logit is a variant of regression analysis where the dependent vari-
able takes one discrete value and the predicted value is interpreted as the log
of the odd ratio. Studies by Abdul Aziz and Lawson (1989) and Abdul Aziz
et al. (1988) combined the logit technique with the multiple discriminant
analysis and cash flow variables with financial ratios (Altman ratios). Ohlson
(1980) used conditional logit analysis that conditioned failure in one year on
the failure status in the first year. But the model was less successful than the
Altman model. Zavgren (1983) extended Ohlson work where both logit and
probit analysis were adopted to estimate the probability of failure. The con-
cern of Zavgren study was not predicting failure as such but rather to analyze
the significance of various financial variables and their coefficients in distin-
guishing between bankrupt and nonbankrupt companies. The results obtained
by these models, in general, were less accurate in predicting bankruptcy than
the previous discriminant analysis models.
A relatively new group of studies have sought solutions for the MDA
problems in the use of a type of artificial intelligence known as neural network
that is free from the requirements of discriminant analysis. This computing

method does not require or assume linearly separable or independent variables.
Computers are used to simulate processes in order to identify behavior patterns.

However, the studies that used this technique, such as Karles and Prakash
(1987), for predicting bankruptcy were not outstandingly successful. Recently,
a study by Coats and Fant (1993) compared the classification performance of
MDA and neural networks based on Altman’s Z score ratios and found that the
two methods perform comparably. Similar results were obtained by Altman et
al. (1994) where the comparison of the two methods concludes that discrimi-
nant analysis, regardless of its shortcomings, is performing as good as or
sometimes better than the neural network. They point out to ‘‘over-fitting’’
problem and illogical types of behavior that grows with the increased complex-
ity of the network structure. In short the neural network method does not
compensate for its complexity and what the authors suggest is to admit the
neural network method in integrated models with discriminant analysis tech-
niques.
More recently, some studies sought to improve upon the predictive ability
of dicriminant analysis by incorporating variables or incremental information
over that contained in financial ratios. For example, Richardson et al. (1998)
controlled for economic recession, Laitinen and Laitinen (1998) introduced
corporate model (inventory cash management model), and Bardos (1998)
combined industry and individual company variables. These studies, on a
whole, traced improved classification accuracy.
Similar studies that are not different in principle from the US studies were
made in other developed economies such as the United Kingdom (e.g., Elhen-
nawy and Morris, 1983), France (e.g., Micha, 1984), Germany (Baetge, Huss
and Niehaus, 1988), Australia (Booth, 1983) and many others. Also some
bankruptcy prediction studies are carried out in developing economies such
as India (e.g., Bhatia, 1988), Malaysia (e.g., Bidin, 1988), Singapore (e.g., Ta
and Seah, 1988), Uruguay (e.g., Pascale, 1988), Turkey (e.g., Unal, 1988),
and Italy (e.g., Altman et al., 1994).
However there is a sheer number of business failure studies that has been
conducted in less developed countries. Thus, this study attempts to apply the
financial ratios, as individual predictors, and as groups in a relevant statistical
model on a sample of private companies in the Sudan, an African less devel-
oped country. The study attempts, in effect, to apply the existing failure
models to the case of private companies in the Sudan and seeks to develop a
simple model that fits the simple economic structure of the country.
DATA AND METHODOLOGY

The collection of data for failed companies requires a definition of failure
and specification of population from which companies are drawn. In this
study a company is considered to have entered the failure process if it is

liquidated or reorganized as a result of incurring a net operating loss or if it is
unable to pay its debts and taxes as they come due. The population bound-
aries are defined by the time period from 1970 to 1996 and that the company
must be classified as private.
The initial sample consisted of 81 private companies that failed in the
previous context during the period 1970-1996. Because of inconsistencies in
the data, or their unavailability for some of the years, only 34 of the original
sample satisfied the complete data criterion for estimating the variables. Later
in the analysis, four of these were considered as outliers and taken out of the
sample. The final sample consists of 15 trading, 8 industrials and 7 transport
companies.
Every failed company in the sample is matched to a non-failed one from
the same industry and same year of the financial information provided and
approximately the same asset size. A great difficulty in exact matching of
asset size is encountered due to the unavailability of data. Other than the
limitations placed by the unavailability of data, the selection of the failed
firms was random. Data for the sampled companies was gathered from their
audited annual financial reports.
For each company and for each of the four years preceding failure, the 18
ratios listed in Table 1 are computed. The factors that are taken into account
in selecting the ratios are:
S The availability of data that permitted the calculation of the chosen ra-
tios across Companies and over time.
S The appearance in the literature as relevant indicators of the firm suc-
cess/failure status.
S The development of a comprehensive set of data by major category;
Profitability, activity, liquidity, and indebtedness ratios (Damboleno and
Khoury, 1980).
The considerable merits of these ratios in financial analysis and in the

measurement of financial well being of corporate entities are well docu-
mented in the literature.
RESULTS
Profile Analysis
In order to determine the ability of single financial ratios to differentiate

between the failed and nonfailed firms, a comparison was made between the
TABLE 1. Ratios Used in the Analysis

Liquidity Measures:
1. Working capital to total asset ratio (WC/TA) = working capital/total assets

2. Current ratio (CA/CL) = current assets/current liabilities
Profitability Measures:
3. Return on asset (P/TA) = net income/total asset

4. Profit margin on sales (P/S) = net income/sales
5. Operating profit to total asset (OP/TA) = operating profit/total assets
6. Net operating margin (OP/S) = operating income/sales
7. Retained earnings to total asset (RE/TA) = retained earnings/total assets
Activity and turnover measures:
8. Fixed-asset turnover (S/FA) = sales/fixed assets

9. Total asset turnover (S/TA) = sales/total assets
10. Working capital to sales (WC/S) = (current assets-current liabilities)/sales
11. Expenses to operating revenue (Exp./S) = expenses/operating revenue
Indebtedness Measures:
12. Cash flow to total debt (CF/TD) = Cash income/total debt

13. Debt ratio (TD/TA) = total debt/total asset
14. Time interest earned (EBIT/I) = EBIT/interest expenses
15. Fixed-charges coverage (CF/FC) = Cash income available for meeting fixed Charges/fixed charges
16. Operating income to fixed charges (OP/FC) = EBIT/fixed charges
17. Net worth to total debt (NW/TD) = net worth/total debt
18. Current liabilities to total asset (CL/TA) = current liabilities/total assets
financial ratios of the failed and nonfailed firms. Since the individual member
of each group has been carefully matched, any statistical differences that are
found between the groups would appear to be due to the failed-nonfailed
status. It is expected that the average failed company was less efficient, less
liquid and less profitable relative to the average nonfailed firm. It is important
to mention that the pairing of the failed and nonfailed firms in the sample
excludes the effect of the exogenous factors that might mask the relationship
between ratios and failure (Beaver, 1966).
The means and standard deviations of the 18 variable profile for the failed
and nonfailed firms are shown in Tables 2 and 3 respectively. The ratios were
calculated for each firm for four years prior to failure.
The results in Tables 2 and 3 over the four years prior to failure show that
TABLE 2. Failed Companies Means and Standard Deviations

Ratio Years Before Failure

1 2 3 4 Average
WC/TA Mean 1.08 0.45 0.15 0.05 0.41
S.D. 2.87 1.62 0.9 0.77 1.54
CA/CL Mean 1.47 1.22 1.52 1.65 1.46
S.D. 2.2 1.53 1.63 1.69 1.29
P/TA Mean 0.66 0.12 0.08 0.02 0.22
S.D. 1.22 0.52 0.29 0.85 0.56
P/S Mean 1.25 0.53 0.45 0.84 0.68
S.D. 3.14 1.33 1.07 4.43 1.54
OP/TA Mean 0.54 0.26 0.14 0.08 0.26
S.D. 1.21 0.96 0.33 0.85 0.71
OP/S Mean 1.26 0.75 0.61 0.76 0.74
S.D. 3.1 1.49 0.98 4.25 1.41
RE/TA Mean 0.76 0.59 0.05 0.14 0.29
S.D. 3.93 3.15 0.53 0.47 1.89
S/FA Mean 10.45 19.69 19.01 19.68 43.71
S.D. 30.59 29.95 30.64 31.99 140.22
S/TA Mean 1.99 1.89 1.16 1.48 1.63
S.D. 4.5 2.44 1.38 2.05 1.84
WC/S Mean 1.06 1.21 0.906 2.94 1.53
S.D. 3.52 4.25 2.22 10.53 4.37
EXP./S Mean 1.46 1.06 0.65 1.32 1.12
S.D. 3.83 1.41 0.72 4.01 1.48
CF/TD Mean 0.498 0.09 0.105 0.44 0.18
S.D. 1.16 0.7 0.52 5.77 1.52
TD/TA Mean 1.91 1.25 0.99 0.806 1.24
S.D. 2.69 1.52 0.75 0.648 1.23
EBIT/I Mean 250.43 151.94 69.42 221.44 173.31
S.D. 532.88 1052.79 428.88 641.49 496.73
CF/FC Mean 144.6 246.83 24.18 164.98 133.06
S.D. 320.25 630.49 574.12 630.59 372.8
OP/FC Mean 395.96 384.85 125.13 257.79 290.93
S.D. 647.22 789.48 424.91 649.39 472.2
NW/TD Mean 1.57 1.52 2.52 5.45 2.76
S.D. 3.81 3.12 4.91 12.97 4.78
CL/TD Mean 1.81 1.14 0.89 0.71 1.14
S.D. 2.71 1.54 0.78 0.68 1.26
the mean liquidity, profitability and turnover ratios of the failed companies
were low and decreasing relative to those of their nonfailed counterparts
while the leverage ratios were higher and increasing as failure approaches.
Moreover, tracking the means of the financial variables of the nonfailed
companies show relative stability and in some cases improving over the time
TABLE 3. Nonfailed Companies Means and Standard Deviations

Ratio Years Before Failure

1 2 3 4 Average
WC/TA Mean 0.22 0.19 0.19 0.1 0.125
S.D. 0.27 0.29 0.26 1.31 0.5325
CA/CL Mean 1.82 2.07 1.46 7.3 3.2
S.D. 2.4 2.6 1.75 34.4 9.5
P/TA Mean 0.13 0.16 0.09 0.03 0.09
S.D. 0.17 0.19 0.2 0.42 0.17
P/S Mean 0.28 0.09 0.03 0.01 0.1
S.D. 1.17 0.22 0.21 0.23 0.36
OP/TA Mean 0.01 0.01 0.02 0.07 0.007
S.D. 0.44 0.57 0.25 0.43 0.33
OP/S Mean 0.21 0.03 0.04 0.09 0.01
S.D. 1.19 0.37 0.26 0.33 0.42
RE/TA Mean 0.13 0.104 0.06 0.07 0.09
S.D. 0.32 0.16 0.14 0.13 0.16
S/FA Mean 51.7 52.53 48.75 37.6 47.65
S.D. 111.09 84.44 130.61 103.01 98.46
S/TA Mean 1.83 2.78 1.58 1.17 2.04
S.D. 2.29 3.97 1.84 1.11 1.75
WC/S Mean 0.169 0.226 0.682 0.886 407
S.D. 1.98 1.63 4.22 4.56 2.98
EXP./S Mean 0.3 0.22 0.28 0.24 0.26
S.D. 0.35 0.24 0.26 0.247 0.22
CF/TD Mean 0.32 0.58 0.29 0.093 0.32
S.D. 0.97 1.1 0.87 1.11 0.79
TD/TA Mean 0.65 0.73 0.68 0.895 0.738
S.D. 0.26 0.64 0.33 1.33 0.447
EBIT/I Mean 30.02 8.81 44.42 45.04 27.67
S.D. 261.6 214.21 406.38 291.61 286.22
CF/FC Mean 0.95 50.27 38.17 2.28 21.78
S.D. 275.68 280.96 632.45 345.45 357.05
OP/FC Mean 42.27 2.03 18.41 27.01 13.23
S.D. 272.43 350.84 664.41 373.21 393.6
TD/NW Mean 4.36 5.13 9.42 5.45 1.38
S.D. 15.35 12.92 107.54 26.15 26.68
CL/TD Mean 0.63 0.74 0.76 0.93 0.76
S.D. 0.31 0.66 0.51 1.33 0.49
period examined. The figures in Appendix A to this study depict the behavior
of ratios in each category over time.
Overall the figures in Appendix A indicate that those ratios are capable, in
principle, of highlighting future financial difficulties of the troubled firms.
The statistical student T and the F-statistics are used to check for any signifi-
cant differences between the two groups means.
Formally, a test for such differences is conducted, where the null hypothe-
sis is stated as:
H0: NF = NNF
while the alternative hypothesis is:
H1: NF < NNF
for profitability, liquidity, activity and turnover ratios. and
H1: NF > NNF
For leverage ratios,

Where: NF = the mean of the failed firms and
NNF = the mean of the nonfailed firms
The statistical results in Table 4 indicate significant statistical differences

for 12 out of the 18 variables in the first year preceding failure, 10 for the
second year, 7 for the third year and only one ratio is significantly different in
the fourth year prior. The null hypothesis is rejected, and it is concluded that
there is a significant difference between the two population means with P/TA
and CF/TD as the most significant ratios.
It is clear from Table 4 that the significance levels of most of the variables
increases relative to the average nonfailed firm as failure approaches. Based
on this result, we are apt to choose the ratios that show significant differences
between the two samples for further analysis. A priori one may expect that
the ratios that show significant differences are more likely to show strong
discriminating power in multiple discriminant analysis in the forthcoming
sections. It is evident from the table that differences between profitability
ratios of the failed and nonfailed firms are significant for most of the time
periods covered. There are also significant differences between debt ratios
with the cash flow to total debt ratio (CF/TD) shows the most significance
difference. However, the activity ratios show the least significant differences
among these ratios.
The differences between the two group variances are shown in Table 5
where the F values indicate highly significant differences for most of the
variables and years. This result may go counter to the underlying assumption
of the MDA, which is used in the subsequent section, regarding the distribu-
tional assumptions of the failed and nonfailed groups. However, as men-
tioned by Ohlson (1980) this difference is not important since the purpose of
the analysis is to establish a discriminating device. Moreover, adoption of
TABLE 4. T-Test for Equality of Means

RATIO Years Before Failure

1 2 3 4
WC/TA 2.52** 2.13** 1.98*** 0.53
CA/CL 2.50** 1.94*** 1.42 0.9
P/TA 3.49* 2.83* 2.56** 0.006
P/S 2.52** 2.52** 2.41** 1.04
OP/S 2.42** 2.57** 3.1* 0.86
OP/TA 2.35** 1.34 2.12** 0.07
RE/TA 1.23 1.21 0.16 0.71
S/FA 2.29** 2.01** 1.21 0.91
S/TA 0.18 1.05 1.01 0.74
WC/S 1.67 1.18 0.257 0.98
EXP./S 1.66 3.23* 2.63* 1.47
CF/TD 2.94* 2.04** 0.98 0.49
TD/TA 2.55** 1.73*** 2.03** 0.33
EBIT/I 2.03** 0.819 0.23 1.37
CF/FC 1.89* 2.36** 0.09 1.24
OP/FC 2.76* 2.43** 1 1.69
NW/TD 0.31 0.298 0.74 2.002**
CL/TA 2.38** 1.31 0.76 0.78
The null hypothesis (Ho: uF = unF) and the alternative hypothesis (H1: uF < uNF) for profitability, liquidity and
activity ratios.
For leverage ratios the alternative hypothesis is H1: uF > unF.
* Significant at .01 level
** Significant at .05 level
*** Significant at .10 level
statistical methods that do not require the restrictive assumptions of the

MDA, such as logit and probit models, has not resulted in significant im-
provements in the predictive ability of failures. Even inclusion of instability
measures, such as the standard deviation of ratios, has not achieved consider-
able merit over traditional MDA.
In the coming section, the dichotomous classification technique will be
applied to test the success of the financial ratios, rather than their means, in
classifying companies into their respective failed/nonfailed groups. As stated
by Beaver (1968) the comparison of variable means offers limited insight
since the interpretation of a difference in means is conditional on the extent to
which distributions overlap.
TABLE 5. F-Test for Equality of Variances

Years Before Failure

RATIO 1 2 3 4
WC/TA 117.62* 30.92* 12.0* 2.93*
CA/CL 3.16* 2.94* 1.15 415.0*
P/TA 54.29* 7.77* 2.1** 4.12*
P/S 7.16* 36.43* 25.49* 372.19*
OP/S 7.6* 2.88* 1.77 3.88*
OP/TA 6.81* 16.22* 14.35* 168.51*
RE/TA 147.47* 373.88* 15.42* 12.4*
S/FA 13.19* 7.95* 18.17* 10.27*
S/TA 3.86* 2.63* 1.78 3.38*
WC/S 3.15* 6.79* 3.61* 5.33*
EXP./S 122.05* 33.63* 7.92* 292.65*
CF/TD 1.44 2.48* 2.85* 26.88*
TD/TA 109.38* 5.59* 5.11* 4.197*
EBIT/I 4.15* 24.16* 1.11 4.84*
CF/FC 1.35 5.04* 1.21 3.33*
OP/FC 5.64* 5.06* 2.44* 3.03*
NW/TD 2.29** 1.04 1.94** 75.67*
CL/TA 74.23* 5.52* 2.29** 3.83*
* Indicates significance at .01 level
** Indicates significance at .05 level
Dichotomous Classification
Beaver dichotomous procedure is followed in this study with one excep-

tion that the number of correct classifications, not the number of errors,
resulting from the use of each of the ratios is counted for only four years prior
to failure. As such 18 ratios are calculated for each company. The overall set
of companies was then divided into subsamples, each consisting of about half
of the pairs of companies. The companies in each subsample were then
ranked by the values of their ratios. The value of each ratio in one subsample,
which showed the smallest number of misclassifications, was then used as the
critical value of the ratio for classifying the firms in the second subsample. The
procedure was then reversed by determining a critical value of each ratio in the
second subsample to classify the firms in the first subsample. The number of
correct classifications resulting from the use of each of the ratios is calculated
for four years before failure. The better predictors were deemed to be those
which showed the highest correct classification rates. Dichotomous classifica-

tion results are summarized in Table 6 along with ranking of these ratios within
each category. A careful look at the table shows that most ratios correctly
classify the firms at high accuracy rates with the profitability ratios being the
most powerful predictors. The debt ratios come next with similar strong per-
formance with low rates of Type I error, while the liquidity and activity ratios
show moderate classification success and with high Type II errors.
Regardless of the relative success of the profile analysis and dichotomous
classification, these approaches still suffer from the shortcomings that the
individual ratios are not normally distributed around an average or a critical
value. Moreover, both methods do not allow for the interaction between these
TABLE 6. Dichotomous Classification Performance (%)
Years Before Failure

1 2 3 4
Ratio Overall Type I Type II Overall Type I Type II Overall Type I Type II Overall Type I Type II
Success Error Error Success Error Error Success Error Error Success Error Error
WC/TA 67 43 23 63 47 27 55 50 40 47 63 43
CA/CL 73 30 23 65 36 30 58 53 30 50 56 43
OP/S 80 10 30 72 27 30 73 37 17 48 63 40
P/S 80 27 13 80 30 10 73 40 13 63 60 13
P/TA 80 30 10 72 47 10 72 42 17 65 10 60
OP/TA 78 13 30 70 40 20 60 40 40 60 57 23
RE/TA 68 60 3 67 67 10 65 60 10 53 70 60
S/TA 72 37 20 53 53 40 57 57 30 45 67 43
S/FA 70 47 13 57 50 37 52 37 60 50 40 60
WC/S 83 17 17 80 3 37 78 3 40 78 13 30
EXP./S 75 20 30 72 33 23 57 37 50 57 37 50
CF/TD 85 16 13 78 16 20 72 53 3 67 33 33
EBIT/I 80 17 23 80 13 27 75 17 33 65 57 13
CF/FC 78 20 23 77 37 10 75 47 3 58 63 20
TD/NW 73 47 7 62 57 20 63 40 33 48 40 63
OP/FC 72 27 30 72 20 37 70 37 23 57 60 27
TD/TA 72 53 03 67 47 20 62 53 23 53 70 23
NW/TD 67 57 10 65 57 13 62 63 12 53 80 03
CL/TA 60 53 27 52 67 30 52 63 33 55 77 13
1. Type I error indicates the probability of classifying bankrupt companies as nonbankrupt.
2. Type II error indicates the probability of classifying nonbankrupt companies as bankrupt ones.
variables. Thus, this study proceeds to examine the models that allow for the
simultaneous incorporation and interaction of variables in statistical models.
Multivariate Models
In this section Multiple Discriminant Analysis (MDA), which is a multi-

variate extension of univariate ratio analysis is employed to identify financial
characteristics, in form of financial ratios, which distinguish between the failed
and nonfailed firms. The empirical examination in this section proceeds as
follows: First, the Altman original Z score model is replicated, retaining all
its variables and estimated coefficients. Second, Altman original Z score
model variables are retained but their coefficients are re-estimated. Third, a
new model is estimated where both its variables and coefficients are com-
puted from the sample.
Replication of Altman’s Z-Score Model
Since all companies in this study are private, the revised Z-score model
recommended by Altman for private company application seems appropriate.
Altman’s version of the private (unlisted) firms is specified as:
Z = 0.717 X1 + 0.847 X2 + 3.107 X3 + 0.420 X4 + .998 X5
Where: X1 = working capital/total asset; X2 = retained earning/total asset;

X3 = earning before interest and tax/total asset; X4 = market value of equity/
book value of debt; X5 = sales/total asset; and Z = overall index
Re-Estimation of Altman’s Model Parameters
The next step is to retain the Altman’s Z score model variables but re-esti-
mate its parameters from our sample data. This step is necessary because the
variables and variable loadings may be sample specific and sensitive to both
time and firm size (Zavgren 1983, Blum 1974, and Moyer 1977). Using
SPSS DIRECT procedure (see Kinner and Gray, 1994) and Altman’s Z model
variables the following discriminant function is shown as giving the best
classification results:
Z* = .087 + .133 X1 + .136 X2 + .992 X3 + .044 X4 + .120 X5
The variables are as specified above.

Table 7 shows both Altman replicated and reestimated model characteris-
tics and their overall goodness of fit.
TABLE 7. Altman Z Models Characteristics

X1 X2 X3 X4 X5 constant X2/F Sig.

Altman replicated model .717 .847 3.10 .420 .998 -- 20.33 .01
Altman reestimated model .133 .136 .992 .044 .120 087 14.78 .01
The New Model
The remaining step is to use the sample to develop an empirical model that
may fit the sample data better than Altman variables. Thus, to eliminate any
presupposed importance for any of the variables the SPSS DISCRIMINANT
procedure is used and after many computer runs over different ratio profiles
three ratios were found to give the best predictive ability.
The final discriminant function arrived at is as follows:
Z** = .015 + .203 X1 + .639 X2 + .561 X3
Where: X1 = Current asset/current liabilities ratio; X2 = operating Profit/total

assets ratio; X3 = Cash flow/total debt ratio.
The model is intuitively appealing since it combines three important and
integrative ratios. For a company to stay healthy it has to make a profit, but
profitability loses its value if the company is not liquid. Similarly, the cash
availability is the most liquid asset that helps companies in times of difficul-
ties. This is specially correct in an LDC where it is sometimes difficult to
transform liquid assets into cash without incurring losses. Furthermore, the
unavailability of credit and developed financial markets add more to the
importance of these ratios to an LDC company. Funds in less developed
countries are scarce and capital and money markets in less developed coun-
tries are narrow and has dual and complex structures (Ghatak, 1995).
Table 8 shows the characteristics of the final discriminant model. The
highly significant chi-square in panel A of Table 8 indicates an overall good-
ness of fit, while the partial F statistics indicate the significance and the
additional discrimination introduced by the individual variable after taking
into account the discrimination already achieved by other variables.
As panel A of Table 8 shows, the ranking of the variables according to
their relative contribution to the group separation indicates that the cash flow
over total debt (CF/TD) variable contributes the most to the overall power of
the model. This result is not surprising since this same ratio was selected by
Beaver (1966) as the best single predictor and it is widely believed that cash
flow is the most important element to cater for debt. Table 4 shows that the
difference between the variable means of failed and nonfailed companies was
TABLE 8. The New Model Characteristics

X1 X2 X3 constant X2 Sig.
Panel A CA/CL OP/TA CF/TD
Coefficient .203 .639 .561 .015 16.358 .001

Partial F* 6.27 7.12 8.67
Significance .001 .0017 .0016
Panel B Pooled Correlation Matrix

X2 X3
X2 .0067
X3 .1557 .022
* Partial F indicates additional discrimination introduced by the variable
significant one and two years before failure while Table 6 of dichotomous
classification shows that CF/TD ratio has high success rates and low Type I
errors for almost all years. The second ranked variable is the operating profit/
total assets (OP/TA) variable, which is a profitability ratio and was one of the
most powerful variables in Altman (1968) and Altman et al. (1977) models.
Similarly, Table 4 shows strong significant difference between the failed and
nonfailed group means while Table 6 shows small Type I errors for this ratio.
The third ranked variable is the current assets/current liabilities which is a
liquidity measure and again it was common explanatory variable in both
Beaver (1966) and Altman et al. (1977) studies. The current ratio was found
to be more informative than other liquidity measures such as the working
capital ratio (Altman 1993). Similarly, the cross correlation between vari-
ables in panel B of Table 8 shows weak and insignificant correlation between
the chosen variables as a further evidence of their additional discriminating
power. As argued by Johnson (1970) the assumption of mutually independent
ratios is necessary for multivariate discriminant analysis to hold. The use of
highly correlated ratios introduces instability of the function coefficients.
Comparison of the Multivariate Models
In this study the criteria for comparing the multivariate models are:
S the overall sample classification accuracy

S Failed companies identification
S Nonfailed companies classification accuracy
Table 9 shows the results of comparing the three models over the four years
prior to failure. Panel A shows the overall classification accuracy of the
models. Altman original Z model is not overall successful in classifying the
sample. The insignificant t statistics indicate that the model is not better than
TABLE 9. Classification Accuracy of Discriminant Analysis Models

Panel A: Overall classification accuracy (%)

Years prior to Original Z Value of Reestimated Value of The New Value of
failure model t (a) Z model t (a) model t (a)
1 55 .77 80 4.64* 87 5.68*
2 45 .77 67 2.63* 75 3.87*
3 43 1.08 65 2.32** 60 1.55
4 25 3.87* 55 .77 53 .464
Panel B: Failed firm identification Accuracy (%)

Years prior to Original Z Value of Reestimated Value of The New Value of
1 67 1.86*** 63 1.42 77 2.92*
2 50 0 33 1.86*** 53 .33
3 54 .44 33 1.86*** 27 2.55**
4 37 1.42 17 3.61* 17 3.65*
Panel C: Nonfailed from identification Accuracy (%)

Years prior to Original Z Value of Recomputed Value of The New Value of
1 43 .76 97 5.15* 97 5.12*
2 40 1.09 100 5.48* 97 5.12*
3 33 1.86*** 97 5.15* 93 4.74*
4 14 3.94* 93 4.71* 90 4.38*
(One) t = (proportion correct--.5)/((.5(1-.5)/n)1/2 (Altman 1993)

* Indicates significance at .01 level
** Indicates significance at .05 level
*** Indicates significance at .10 level
a random classification process. However, both the reestimated Altman Z

model and our model show high accuracy rates one and two years prior to
failure, with our model outperforming the reestimated Z model in both years.
However, both models performance three and four years prior is not satisfac-
tory.
As Table 9 shows, the original Z model has an overall success rate of
(55%) one year prior to failure, and only 45% two years prior and it declines
steadily three and four years prior. The results show that the original Altman
Z model parameters are less predictive when applied to our sample. Many
studies have shown that Altman’s model success rate is sensitive to either the
time span or firm size or both. In addition to these two factors, the lower
success rate reported in Table 9 could be attributed to the variation between
the economic environment of an LDC and that of a developed economy such
as that of the U.S. We conclude that the higher overall success rate (93%
correct classification) reported in Altman’s study could not be obtained when
the exact model is applied to a new different sample of private companies in
an LDC. Thus, these results show that the model parameters and its overall
performance are sensitive to the sample being used.
However, the performance of the three models in identifying the failed

companies, which is more important than the identification of the nonfailed
ones, is quite different than their overall performance. Panel B of Table 9
shows that our model still outperforms Altman models one and two years
prior to failure. However, Altman original Z model shows unexpectedly high
correct classification rate, with Altman reestimated model shows the least
performance. However, this performance is reversed when identifying the
nonfailed performance, where the Altman original Z model was not success-
ful at all in correctly identifying this group. However, panel C of Table 9
shows that both our model and Altman Reestimated Z model classification
accuracy is comparable.
CONCLUSION
The purpose of this study has been to examine the characteristics of a
sample of failed and nonfailed companies in the Sudan, an African LDC, in
order to develop an early warning system to serve as a tool for identifying
problematic companies.
In order to achieve this objective the paper has attempted to apply various
methodologies to predict failure. The study first applied profile analysis and
dichotomous classification measures introduced by Beaver. The results
showed relative strong performance for most of the ratios especially the debt
ratios and liquidity ratios and some of the profitability ratios. However, the
turnover ratios were low over the period of the study. It is worth mentioning
that the Sudan was suffering from inflation during the period where holding of
goods and products is considered better than selling. This is especially true
because the country is lacking strong capital markets and facing hard currency
problems. Next the paper applied a version of Altman Bankruptcy Z model
developed for private companies to the sample and found that the performance
of the model was not strong with successful classification rates of 55%, 45%,
43%, and 25% one, two, three, and four years prior to failure respectively.
The Altman Z model parameters were next re-estimated using the sample
data set. The predictive ability of the model improved significantly to the
effect that the successful classification rate increased to 80%, 67%, 65%, and
55% one, two, three, and four years prior to failure respectively.
However, using a stepwise MDA the study developed a reduced variable
model that includes only the current ratio (liquidity measure), earning power
ratio (profitability measure), and cash flow to total debt ratio (leverage mea-
sure). The model achieved considerable improvement in the successful clas-
sification rate that reached 86.67%, 75%, 60%, and 53% one, two, three and
four years prior to failure respectively.
Finally, the paper compares the three models in terms of their overall
successful classification ability, failed companies identification, and nonfailed
company’s accurate classification. The results show that the model developed
in this study outperforms Altman replicated and reestimated Z models in its
overall classification rate one and two years prior to failure, while showing
comparable results to that of the best of Altman models three and four years
prior to failure.
The same pattern is shown in identifying the failed companies one and two
years prior to failure. For three and four years before failure the three models
were not successful in identifying failed companies. However, in identifying
nonfailed companies the Altman replicated Z model shows outstanding per-
formance, and so is our model. The original Altman Z model was utterly
failed in recognizing nonfailed companies.
In summary, the paper shows that simple techniques and models in a simple
economic environment can do as good or better a job than complex models
originated in developed economies. Further, the three integrated ratios that
show up in the final discriminant model, which are the profitability ratio, the
liquidity ratio and the cash to debt ratio, have an intuitive appeal in a less
developed economy such as that of the Sudan. The study shows that in such
economy profitability and liquidity are ingredients for successful business.
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RECEIVED: 09/03/99
REVISED: 11/29/99
ACCEPTED: 01/14/00
APPENDIX A
WC/TA RATIO CA/CL RATIO P/TA RATIO

8 0.4
0.4 0.2
0.2 6
0 4 0
--0.2 1 2 3 4 --0.2 1 2 3 4
--0.4 2
--0.6 0 --0.4
--0.8 1 2 3 4 --0.6
--1 --0.8
--1.2
Figure (1) Figure (2) Figure (3)
P/S RATIO OP/S RATIO OP/TA RATIO

0.4
0.2
0 0.5
1 2 3 4 0.2
--0.2 0 1 2 3 4 0
--0.4 --0.5 --0.2 1 2 3 4
--0.6 --1 --0.4
--0.8 --1.5 --0.6
RE/TA RATIO S/FA RATIO S/TA RATIO

3
60 2.5
0.5 2
40
0 1.5
1 2 3 4 20
--0.5 1
0
--1 0.5
1 2 3 4
0
1 2 3 4

WC/S RATIO 1.6 EXP./S RATIO CF/TD RATIO

1.4
0.5 1.2
0 1 2 3 4 1
--0.5 0.8
--1 1
--1.5 0.6
0.4 0.5
--2
0.2 0
--2.5
--3 --0.5 1 2 3 4
0
--3.5 1 2 3 4 --1
TD/TA RATIO EBIT/I RATIO CF/I RATIO

100
2.5 50
2 0
1.5 100 --50 1 2 3 4
1 0
0.5 --100
--100 1 2 3 4
0 --200 --150
1 2 3 4 --300 --200
--250
--300
OP/I RATIO NW/TD RATIO CL/TA RATIO

2
1.8
6 1.6
1.4
50 5 1.2
0 1
--50 1 2 3 4 4 0.8
--100 0.6
--150 3 0.4
--200 2 0.2
--250 0
--300 1 1 2 3 4
--350
--400 0
--450 1 2 3 4
* Note: NonBankrupt = Bankrupt =

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This article was downloaded by: [Chulalongkorn University]

On: 08 January 2015, At: 01:30

Journal of African Business

Predicting Private Companies

To link to this article: http://dx.doi.org/10.1300/J156v02n02_03

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ABSTRACT. This paper applies failure prediction techniques to a

KEYWORDS. Business failure, profile, dichotomous, MDA, Less De-

Abuzar M. A. Eljelly, DBA, is Assistant Professor of Finance, Department of

continuous pursuit of building models that are meant to help predicting

that is free from the requirements of discriminant analysis. This computing

Computers are used to simulate processes in order to identify behavior patterns.

DATA AND METHODOLOGY

study a company is considered to have entered the failure process if it is

The considerable merits of these ratios in financial analysis and in the

In order to determine the ability of single financial ratios to differentiate

TABLE 1. Ratios Used in the Analysis

1. Working capital to total asset ratio (WC/TA) = working capital/total assets

3. Return on asset (P/TA) = net income/total asset

Activity and turnover measures:

8. Fixed-asset turnover (S/FA) = sales/fixed assets

12. Cash flow to total debt (CF/TD) = Cash income/total debt

TABLE 2. Failed Companies Means and Standard Deviations

Ratio Years Before Failure

TABLE 3. Nonfailed Companies Means and Standard Deviations

Ratio Years Before Failure

while the alternative hypothesis is:

H1: NF < NNF

for profitability, liquidity, activity and turnover ratios. and

H1: NF > NNF

For leverage ratios,

The statistical results in Table 4 indicate significant statistical differences

TABLE 4. T-Test for Equality of Means

RATIO Years Before Failure

statistical methods that do not require the restrictive assumptions of the

TABLE 5. F-Test for Equality of Variances

Years Before Failure

Beaver dichotomous procedure is followed in this study with one excep-

which showed the highest correct classification rates. Dichotomous classifica-

TABLE 6. Dichotomous Classification Performance (%)

Years Before Failure

In this section Multiple Discriminant Analysis (MDA), which is a multi-

Replication of Altman’s Z-Score Model

Z = 0.717 X1 + 0.847 X2 + 3.107 X3 + 0.420 X4 + .998 X5

Where: X1 = working capital/total asset; X2 = retained earning/total asset;

Re-Estimation of Altman’s Model Parameters

Z* = .087 + .133 X1 + .136 X2 + .992 X3 + .044 X4 + .120 X5

The variables are as specified above.

TABLE 7. Altman Z Models Characteristics

X1 X2 X3 X4 X5 constant X2/F Sig.

The New Model

Z** = .015 + .203 X1 + .639 X2 + .561 X3

Where: X1 = Current asset/current liabilities ratio; X2 = operating Profit/total

TABLE 8. The New Model Characteristics

Coefficient .203 .639 .561 .015 16.358 .001

Panel B Pooled Correlation Matrix

Comparison of the Multivariate Models

S the overall sample classification accuracy

TABLE 9. Classification Accuracy of Discriminant Analysis Models

Panel A: Overall classification accuracy (%)

Panel B: Failed firm identification Accuracy (%)

Panel C: Nonfailed from identification Accuracy (%)

(One) t = (proportion correct--.5)/((.5(1-.5)/n)1/2 (Altman 1993)

a random classification process. However, both the reestimated Altman Z