Browsing by Author "Steyn, Barbara Wilhelmina"

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    Die gebruik van kontantvloei- en winsgegewens by die beoordeling van genoteerde industriele RSA-maatskappye se finansiele stabiliteit
    (Stellenbosch : University of Stellenbosch, 2005-12) Steyn, Barbara Wilhelmina; Hamman, W. D.; Smit, E. vd M.; University of Stellenbosch. Faculty of Economic and Management Sciences. Dept. of Business Management.
    ENGLISH ABSTRACT: Several mixed industry prediction models about failure have been reasonably successful in differentiating between successful companies and those that have failed. The challenge, however, is to venture into the grey area in between and to identify companies, which are financially unstable, at an early stage. Early identification enables management to intervene timeously in an attempt to prevent failure. Failure is defined as either liquidation, delisting, suspension of listing or a substantial change in structure. The grey area focused on in this study is overtrading. Overtrading is triggered by the company growing at too high a rate relative to its specific structure. Cash is necessary to fund expansion, whether for an increase in inventories, credit sales or new non-current assets. If the company does not generate enough cash to fund this expansion, it has to be financed through external sources. The longer the period of growth and the higher the growth rate, the more the cash requirements. From the theoretical model underlying overtrading, it was found that: • the higher the growth in sales, • the smaller the profit margin, and • the higher the net current assets in proportion to total assets, the lower the cash flow from operating activities before dividends were paid (CFO). Any company ought to generate enough cash from its daily activities in order to maintain the existing level of business, to repay loans, to replace assets and to pay dividends. If the internal generation of cash is insufficient to finance these activities, existing cash resources will be consumed, unproductive non-current assets will be sold and possibly also some of the productive non-current assets. The outcome for such a company is a business combination or liquidation. Due to the fact that cash plays such a big role in failure, cash flow variables constitute the majority of the independent variables used in the development of the failure prediction models. The overtrading ratio was developed as a measurement tool to quantify overtrading. As long as the company generates a positive CFO, it is not so much at risk as a company that does not succeed in generating a positive CFO. Therefore, a negative CFO for a three-year period was decided on as the norm for identifying possible financial difficulty. A company is involved in overtrading if the sum of CFO for three years less the sum of the adjusted profit for the three years, divided by the absolute value of the sum of the adjusted profit for the three years equals -1 or smaller in the case of a company with a cumulative profit for the three years; and smaller than nought in the case of a company with a cumulative loss for the three years. South African industrial companies listed for at least three years during the period 1974 to 2003, were identified. From a total of 6 662 cumulative three-year periods, 944 overtrading years were identified. Failure occurred in 212 out of 526 companies involved in overtrading between January 1974 and August 1989. 120 out of 199 companies involved in overtrading between September 1989 and November 1995 failed, while 90 out of 127 companies involved in overtrading, failed between December 1995 and June 2000. By June 2005 it was already evident that 49 out of 92 companies involved in overtrading between July 2000 and December 2003, had already failed. Companies involved in overtrading, may survive artificially for lengthy periods with the support of providers of capital. It can therefore be expected that failure prediction models will not achieve a better accuracy rate than achieved by probabilities. Six failure prediction models utilising classification tree algorithms were developed. Using data from two periods, two different models were developed; one for growth and recession phases of the economy, the other without distinction between economic phases. The first period was September 1989 to June 2000, the other December 1995 to June 2000. June 2000 was chosen as the cut-off, since a period of five years after an overtrading year was necessary to follow-up whether the company had failed. Each universe was split in two – the learning sample, more or less 60%, and the test sample, more or less 40%. The models were developed from the learning sample and the test sample was used as substantiation of the results of the developed model. The total classification accuracy of the three best models, one for the growth-phase, one for the recession-phase and one mixed economy model, is respectively 72,99%, 96,67% and 80,26% and the classification accuracy for the failed companies 75,29%, 100% and 85,19% respectively. The total prediction accuracy of the three models is respectively 69,23%, 80,95% and 72,55%, and that of the failed companies 73,68%, 86,67% and 83,33%. The accuracy of all the models was found to be higher than what the accuracy would have been if all the companies involved in overtrading were merely classified as having failed. From the results of the different tests, it seems that Ver3, the growth in sales from year 1 to year 3, is probably the most important independent variable in the classification between failed and non-failed overtrading years. This corroborates the theory underlying overtrading that indicates that a high sales growth puts a company at risk for cash flow problems. Companies where the cash flow problems develop because of an increase in current assets will be intercepted by the overtrading ratio. Companies where cash flow problems develop due to replacement of non-current assets, will not necessarily be intercepted by the overtrading ratio as CFO that is used in the overtrading ratio does not allow for replacement of non-current assets. It is therefore necessary to adjust CFO to a free cash flow CFO. Depreciation is used as an alternative for replacement investment since disclosure of replacement investment is not required. Depreciation is theoretically the fraction of the value of an asset lost during the year; this value needs to be replaced. By subtracting the depreciation for the year from CFO, this amount will be more representative of the cash position of the company after considering all the normal transactions in order to sustain the business. After all the adjustments for a free cash flow, six models were developed for the different periods and economic phases. The accuracy of these models were better than what the accuracy would have been if overtrading years were merely classified as failed. Implementing these models would therefore improve specificity. From the tests performed, Ver3 and KVB3/TB (the cumulative CFO for the three years over total assets) seem to be the most important independent variables in the classification between failed and non-failed when considering free cash flow. This is informative as KVB3:TB represents a fictional amount, as if the company spent an amount equal to depreciation on replacement investment.