This document discusses five models for predicting business failure: Beaver's model, Altman's Z score model, Wilcox model, Blum Marc's failing company model, and L.C. Gupta's model. It focuses on explaining Blum Marc's failing company model and L.C. Gupta's model. The failing company model was developed by Marc Blum to assess failure probability using financial data from 115 failed and 115 non-failed companies from 1954-1968. It achieved 94% accuracy for failures within one year and 80% accuracy for failures within two years. L.C. Gupta's study on Indian companies found that earnings before interest, taxes, depreciation and amortization/sales and operating cash

1. Preeti
Roll no- 13
MBA (3rd Sem)

2. 
Five Models
 Beaver Model
 Altman’s Z Score Model
 Wilcox Model
 Blum Marc’s Failing Company Model
 L.C Gupta Model

3. Marc’s Blum Failing Company Model

 The Failing Company Model (FCM) was developed by
Marc Blum to assess the probability of business failure.
 The operational definition of failure used in this study
was an in ability to pay debts as they become due,
entrance into the bankruptcy or explicit agreement with
creditors to reduce debts.
 Analysis was applied to a paired sample of 115 failed and
115 non-failed firms to evaluate the predictive accuracy of
the model.
 Sampling was based on four criteria, utilised in following
order – industry, sales, employees, and fiscal year.

4. 
Conti…
 Data drawn from balance sheets, income statement and stock market prices for
the consecutive prices of at least three years were collected for 115 companies
which failed during the years 1954-1968 and matching 115 non-failed companies.
 He 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.

5. 
Conti..
The 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.

6. L.C Gupta’s Work

 This study is done with Indian data, attempted to distinguish sick
and non-sick companies on the basis of financial ratios.
 The test was based on taking sample of sick and non-sick
companies, arraying them by the magnitude of each ratio to be
tested, selecting a cut off point which will divide array into two
classes with a minimum possible number of misclassification, then
computing the percentage classification error.
 The ratio which showed the least “ percentage classification error”
at the earliest possible time was deemed to have the highest
predictive power.
 The sample included 41 textiles companies of which 21 were non-sick
and 20 were sick to test the predictive power of 56 financial
ratios.
 The financial ratio computed for each of the company in sample for
each year of 13 year period i.e 1964-74

7. 
Conti…
The computation of “ percentage classification error”
 In a mixed sample of 4 sick (S) and 4 Non-Sick (N) firms with their
ROI (for a given year) arranged in an ascending order as follows:
-5 -2 3 4 6 8 10 12
S S (N) S N N (S) N
 The cut off point (arrow) is chosen in such a way that the
number of misclassification (shown in parenthesis) is
minimized.
 The percentage classification error is 25% (2/8).

8. 
Conti…
L. C Gupta’s study revealed that
 EBDIT/ Sales
 OCF / Sales
are the best ratios in predicting future bankruptcies.
 These ratio had the least classification error among all the
profitability ratios for the textile companies sample during
1962-64 .
* OCF = operating cash flow

9. 
Thankyou