Validity of Altman’s “Z” Score Model in Predicting Financial Distress of Pharmaceutical Companies

Prediction of financial distress has been a major concern for all companies since the financial crisis of 2008. Financial distress is detrimental to big and small organisations alike. It is costly because it creates a tendency for firms to do things that are harmful to debt holders and non financial stakeholders, impairing access to credit and raising stakeholder relationships. Again financial distress can be costly if a firm’s weakened condition induces an aggressive response by competitors seizing the opportunity to gain market share. The motivation for empirical research in corporate bankruptcy prediction is clear – the early detection of financial distress and the use of corrective measures (such as corporate governance) are preferable to protection under bankruptcy law. If it is possible to recognize failing companies in advance, then appropriate action can be taken to reverse the process before it is too late. This study uses Altman’s ‘Z’ Score Model to test the financial distress of a few selected
pharmaceutical companies. This model has been applied in several financial distress and bankruptcy studies with satisfactory results. The study covers a period of 5 years viz., 2012-2013 to 2016-2017. For the purpose of investigation, purely secondary data is used. The technique of Altman’s “Z” score test has been applied to analyse the data. The result shows that the average ZScore of the pharmaceutical industry is 5.90 during the period of study. It clearly indicates that the pharmaceutical industry has a healthy financial position because Z-Score is much above the cut-off scores i.e. 1.8.
Keywords: Financial Distress, Liquidity, Pharmaceutical Industry, ALTMAN’S Z Score Test.
A firm’s financial health plays a significant role in its successful functioning. Poor financial health threatens the very survival of the firm and leads to business failures. The financial crisis of 2008 and the ensuing economic downturn have had a significant impact on the corporate sector. Corporate profitability has eroded sharply while debt burden has increased. Corporate failures are a common problem of developing and developed economies.
Proactive efforts can save a company heading towards potential bankruptcy from facing painful consequences of a complete failure. With the global financial crisis of 2008 and the failure of many organisations in the US and Europe, it has become all the more necessary that the stakeholders study the financial health of their organisations. For companies, being able to meet their financial obligations is an integral part of maintaining operations and growing in the future. Liquidity is the ability to meet expected and unexpected demands for cash through ongoing cash flow or the sale of an asset at fair market value. Liquidity risk implies the possibility of a firm not having sufficient funds or liquid assets to meet its cash obligations.

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