Bankruptcy Prediction Since 2002
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LGA White Paper © All Rights Reserved Date Will you go bust during this December-08 recession? Les Glassock of Les Glassock & Associates takes a detailed look at viability predictors for dealers and assesses the chances for • Is Insolvency rising in the UK? Ford, GM and the UK’s largest dealer groups. • Should a UK dealer predict the probability of insolvency for his business and any key credit The Big Three US car makers customers? are inching their way to- • Where can you get a free insol- wards a multi-billion $ slice vency prediction? of the $700BN bank bailout • If Ford and GM don’t get a package from the US Con- large enough bail-out from the gress. Here in the UK, Inch- US Congress, how will it im- pact on Volvo, Saab and their cape, Lookers and Pen- UK dealer networks? dragon have seen their • What is the impact of the share price plummet to lev- Rick Wagoner, GM CEO, 2008 slashing of share prices for els where they are all vul- The hardest hit will be small and medium sized the main UK dealer groups: nerable . But should they businesses in the property, retail and leisure Inchcape, Lookers, Pendragon have seen it coming? Can segments. Although the numbers are lower, and Penske Automotive insolvencies in the automotive retail sector are Group—the owners of Sytner? you foresee financial dis- as bad as the national pattern. Comparing Q3 Will any of them go bust? tress? ‘07 with ‘08, company liquidations have more than doubled and Other Insolvencies are up Insolvency prediction has long been confined 52%. to academic statisticians and accountants. But, with personal computers available to every The immediate causes are that many inde- business, viability prediction models are now pendent dealerships have found it impossible Contents practical and available to all. This recession to renew their credit lines at a reasonable cost, may be the time when prediction ratios join the if at all. But the roots of the problem are often mainstream. much deeper: poor absorption levels, high The why and how of predicting 2 gearing and over-dependence on a market financial distress UK Insolvencies segment or brand that is under severe stress, The limits of distress prediction 3 According to the UK Insol- models vency Service, the number of Predictions for Ford and GM 4 Company Liquidations jumped by over 10% in Quarter 3, 2008 and is running at just Implications for UK dealers 5 below 14,000 for the rolling 12 months. Added to this are 4,600 ‘other insolvencies’, Predictions for UK Quoted 6 which brings the total nearer Dealer Groups to 18,500. The ‘other insol- About Us 7 vencies’ are up 65% on the same period last year. If the trend continues, we are on course for a 40% rise in busi- ness failures in 2009. Page 2 Can you predict financial distress? UK Insolvency in Q3 2008 Why and how of predicting finan- cial distress ? Figures from the UK Government's Insolvency The why is simple: the break-up value of most Service showed liquidations dealers is much lower than the going-concern are rising at their fastest rate value. The shareholders receive much less value when a company is in recognized financial dis- for 18 years, with insolvencies tress than otherwise. between July and September up 26.3pc on last year and All going concerns face credit default risk: they 10.5pc on the previous three extend credit and might not get paid. In fact, months. It was the first time the number of dealer closures is heading to- the figure has topped 4,000 wards 400 in 2008, so for some dealers closure is inevitable. Using a bankruptcy prediction since 2002. model may help reduce the risks. While the total is little over them as well. half the level reached in the Modern bankruptcy prediction is based on large depths of the early 1990s scale analysis of business data using complex Most accountants know about the basics of recession, the steep rise in maths - multiple discriminate analysis (MDA) viability, credit scoring or bankruptcy prediction and probability statistics. the number of firms in models. So, your first port of call might be to administration suggests there ask your accountant to create a simple In simple terms, the data on two groups of spreadsheet for you. The calculations are is more pain to come. businesses is assembled—those that survived widely available for all of the models discussed Administrations numbered and those that failed. Computer pro- 1,007 in the quarter, a 51pc grammes analyse the financial ratios Distress Prediction Free on the Net increase on this time last year and trends of all the businesses in the sample to find which ratios predict and already 12pc higher than Free Excel sheet: bankruptcy. http://www.jaxworks.com/download.htm the whole of 2007. and download Free Excel Dashboard Workbook Small businesses in particular So far, around 11 different financial ratios have been identified which are are bearing the brunt of the Free trial entering your own data online: used in four bankruptcy prediction crisis, with 280 going bust http://www.bankruptcyaction.com/bankpred2.htm every week, according to the models. The 11 ratios are given be- low. http://www.cellspark.com/zscore.html Federation of Small Businesses. Each model is named after the individual who here. Motor retail experts at Grant invented it or the underpinning statistical Thornton predict that more method: Altman, Springate, Fulmer and Logit. If you want a free sample spreadsheet go to than 1,000 franchised outlets More on each of them can be found later in this the Jaxworks site and download one there. will close in 2009. paper. Simple examples, where you just enter your data are available on the Internet free. (see DIY Distress Prediction inset box). So how do you get a viability prediction for your business? If you want a professional Viability Prediction there are lots of proprietary software pro- A viability prediction for your own company is a good starting point, but a small grammes on the market. These range from the dealer may be highly exposed to one or two large fleet or service customers. If most sophisticated, such as RiskAnalyst (Moody the fall of a few large customers could be risky for you, it’s sensible to assess KMV), to easy to use software for under £50, Predictor Ratios closely linked to bankruptcy or survival 3. Earnings Per Share: A profitability ratio, for quoted compa- One recent study suggested that these 11 nies ratios are the best predictors of future fi- 4. Total debt to total capital: Solvency ratio that indicates nancial distress for companies the level of financial distress and vulnerability to recession, in- 1. Working capital ratio: This is a liquidity ratio - measures terest rate rises, etc. 5. Total debt to total assets: As 4 above the ability of a company to meet its short term commitments 6. Cash flow per share: Indication of cash flow and sustain- without having to cease operations or liquidate long term as- ability of the dividend payout sets. 7. Logarithm of tangible asset turnover: Activity ratio indi- 2. Gross Profit Margin: essential for long run survival and Page 3 Can you predict financial distress? payment history with you. Good credit scoring models generally add this informa- such as Credit Controller (Markitsoft). But, tion into their predictions. before spending any cash, check with your own credit controller. You may already be Another issue is whether a model has been tested in different countries. Car retail- using a viability predictor in your credit scor- ing is different in the USA than it is in the UK. Very few models have been tested ing of accounts. If you are just input your across the same industry in different markets. Most have only been tested across own financial statements and look at the different industries in the same market! score you give yourself. Finally, we’ve all learnt, that governments can help or harm the chances of busi- Some practical limits of financial ness success by their economic management. While, professional ratings agency’s distress prediction models take this into account, they are often left out of the models developed by account- ants. All distress prediction models have limitations and are a supplement to, and not a substitute for, good judgement. Ford and GM First, of all, insolvency can be calculated in at least two ways. One is ’cash flow insolvency. It comes as no surprise that US car makers are in financial trouble. Ford made This means that you run out of cash and can’t operating losses of almost $29BN between 1999 and 2007. By the third Quarter of pay your creditors. A second type is ‘negative 2008 the loss deepened by another $8.7BN net worth’’. In this situation, your debts ex- and the entire shareholders equity in the firm ceed the value of your assets. In this situa- was minus $2BN. It has negative net present tion, even if you sold everything, the firm is value: it’s technically bankrupt. insolvent because it cannot repay all of its debts. Not all models measure both of these. So to is GM, but to an even greater extent. For example, Ford and GM do not have cash By September 2008 shareholders funds - the flow insolvency - yet! But, they do have equity in the business - were minus $6BN. debts greater than their asset value. Since 2005 GM has accumulated net losses of $51BN and wiped out equity which took over Another important point: size matters in the a century to build.