Predicting financial distress

Abstract

As well know “world factory”, Chinese manufacturing sector is sensitive to foreign demand. Facing the substantially decreasing foreign demand during the 2008 financial crisis, many manufacturers encountered financial distress or even bankruptcy. Many factors may affect a firm to encounter financial distress, including the firm’s characteristics, performance, risk management, economic development and market trend. Financial distress prediction can function in the way of alarming in advance, correcting poor management, and building immune system. The purpose of this research is to differentiate the financial performance between healthy companies and distressed companies, and to determine factors which possess the ability to predict financial distress when the economy encounters depress. In this paper, distressed manufacturing companies and healthy companies from both SSE and SZSE are examined during 2007-2008. Using logit regression model, the paper shows that liquidity, profitability and financial leverage possess significant powers to predict the probability of financial distress a company may encounter during financial crisis. Moreover, healthy companies have better performance on profitability, liquidation with lower financial leverage than distress companies do.