An evaluation of financial distress prediction measures for listed companies in South Africa

Abstract

The need for additional measures of financial distress for listed companies is tantamount and stems from the ever-increasing number of business failures in South Africa’s current economic climate. This study investigates the prediction capabilities of using liquidity financial ratios, as a method of predicting financial distress and investigates the effect of combining that analysis with a secondary measure, in an attempt to increase the ability of predicting financial distress. This is done by calculating and contrasting the liquidity financial ratios and Ohlson O-scores of forty companies with each other, in order to determine any relevant patterns or differences. These forty companies were divided into two groups of twenty companies, in one group the top 20 listed companies on the JSE and in group two, twenty companies that have been delisted or liquidated within the years of 2015-2017. The financial statements of each company for the three years under scrutiny (top 20 companies) or the three years prior to delisting or liquidation (delisted companies) were used as basis for the calculations of the five primary liquidity ratios and the Ohlson O-score for each company and group. This study found that the ratios under scrutiny behaved unexpectedly in some cases which can easily confuse the researcher when due care is not given to investigating the problem further. While liquidity ratios do have a strong correlation with showing financial distress, they don’t provide a comprehensive prediction model when used in a silo. The addition of Ohlson’s O-score as a secondary measure, improved the predictive capabilities of the analysis. Therefore, this study has found that liquidity financial ratios and Ohlson’s O-score analyses provide more accurate financial distress predictions when combined. Further study with a focus on smaller or private businesses should be conducted, in order to refine the process for non-listed companies.