Modeling Bankruptcy Prediction for Non-Financial Firms: The case of Pakistan

by Qaiser Abbas of the International Islamic University, and
Abdul Rashid of the International Islamic University

January 1, 2011

Abstract: This paper aims to identify the financial ratios that are most significant in bankruptcy prediction for the non-financial sector of Pakistan based on a sample of companies which became bankrupt over the 1996-2006 period. Twenty four financial ratios covering four important financial attributes namely profitability, liquidity, leverage, and turnover ratios) were examined for a five-year period prior bankruptcy. The discriminant analysis produced a parsimonious model of three variables viz. sales to total assets, EBIT to current liabilities, and cash flow ratio. Our estimates provide evidence that the firms having Z value below zero fall into the "bankrupt" whereas the firms with Z value above zero fall into the "non-bankrupt" category. The model achieved 76.9% prediction accuracy when it is applied to forecast bankruptcies on the underlying sample.

JEL Classification: G33.

Keywords: Bankruptcy, Z-Score, Non-Financial Firms, Financial Ratios, Pakistan.

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