1.

Multiple Discriminant Analysis

Discriminant analysis is a statistical technique used to classify and/or make predictions in

problems where the dependent variable appears in qualitative form, e.g. bankrupt or non-
bankrupt. It represents the best way of classifying observations into one of several defined
groupings - known as a priori groups - dependent upon the observation's individual
characteristics. When classifying companies, the financial ratios are to be put into the
discriminant function making up the linear combination. By comparing the discriminant values
that separate bankrupt and non-bankrupt companies, one can determine which group a certain
company belongs to.
The general form of the discriminant function is the following:

Z = b0+b1x1+b2x2+…. +bnxn

Where

Z = discriminant score
b0 = estimated constant
bn = estimated coefficients
xn = independent variables.

2. Logistic Regression

Logistic regression is a specialized form of regression that is formulated to predict and explain a
binary (two-group) categorical variable rather than a metric-dependent measurement (Ong,
Yap & Roy, 2011). Logistic regression utilizes the coefficients of the independent variables to
predict the probability of occurrence of a dichotomous dependent variable (Dielman, 1996). In
the context of bankruptcy prediction, the technique weighs the financial ratios and creates a
score for each company in order to be classified as bankrupt or non-bankrupt. The function in
logistic regression is called the logistic function and can be written as follows:

Pi = 1/ (1+e-zi)
where

pi is the probability the ith case experiences the event of interest

zi is the value of the unobserved continuous variable for the ith case.

3. Financial Ratios

Financial ratios can be applied in many ways. They could be used by managers in any firm in
managerial analysis; they also can be used in credit analysis, and by investors in any investment
analysis. The financial ratio analysis is obtained by using financial statement that have been
published.
.
Financial statement analysis involves a wide variety of ratios and a wide variety of users, including trade
suppliers, banks, credit rating agencies, investors and management, among others. Ratios that are
normally calculated fall under the categories of liquidity, profitability, efficiency and solvency.
Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate
bankruptcy, Journal of Finance, 23(4), 589-609. http://dx.doi.org/10.1111/j.1540-
6261.1968.tb00843.x

Beawer, W. (1966). Financial Ratios as Predictors of Failure.Journal of Accounting Research,

4(3), 71-111.

Ong, S. W., Yap, V. C., & Khong, R. W. (2011). Corporate failure prediction: a study of public listed
companies in Malaysia. Managerial Finance.