Financial Distress and Its
Importance
Financial distress means a company struggles to meet
financial obligations.
It signals risk but is not bankruptcy itself. Early signs include
declining revenues, liquidity issues, rising debt, delayed
payments, and stock price fluctuations.
Predicting distress helps investors, creditors, regulators, and
management act early to reduce risks and improve outcomes.
Evolution of Financial
Distress Prediction Models
Model Developer Year Overview
Altman Z-Score Edward Altman 1968 Uses financial ratios to
predict bankruptcy in
manufacturing firms.
Ohlson O-Score James Ohlson 1980 Logistic regression
predicting bankruptcy
probability for various
firms.
Zmijewski Model Mark E. Zmijewski 1984 Probit regression on key
ratios for bankruptcy
prediction.
Springate Model Gordon L.V. Springate 1978 Multiple discriminant
analysis based on
Canadian data.
Altman Z-Score Model
Explained
Purpose Key Ratios
Predicts bankruptcy risk for • Working Capital / Total
public manufacturing firms Assets
using five financial ratios. • Retained Earnings /
Total Assets
• EBIT / Total Assets
• Market Value of Equity /
Total Liabilities
• Sales / Total Assets
Interpretation
Z > 2.99 safe, 1.81–2.99 moderate risk, <1.81 distress zone.
Ohlson O-Score Model Overview
Purpose Key Variables Decision Rule
Predicts bankruptcy probability • Log Total Assets Probability > 0.5 indicates
using logistic regression with nine • Total Liabilities / Total Assets financial distress risk.
financial variables.
• Working Capital / Total Assets
• Current Liabilities / Current
Assets
• Net Income / Total Assets
Zmijewski Model: A Quantitative-Hybrid
Approach
Key Ratios Decision Rule
• Return on Assets (ROA) Z > 0 predicts bankruptcy; Z < 0 predicts solvency.
• Debt Ratio (Total Liabilities / Total Assets)
Example: Bed Bath & Beyond scored 0.233, indicating
• Current Ratio (Current Assets / Current Liabilities) high bankruptcy risk.
Springate Model for
Bankruptcy Prediction
Ratios Used Interpretation
• Working Capital / Total Score > 0.862 means
Assets financially healthy; below
• EBIT / Total Assets indicates distress risk.
• Net Profit Before Tax /
Current Liabilities
• Sales / Total Assets
Best For
Public, manufacturing, and Canadian firms.
Logistic Regression in Bankruptcy Prediction
Purpose Common Ratios Decision
Predicts bankruptcy probability using • Working Capital / Total Assets Probability > 0.5 predicts bankruptcy;
multiple financial ratios and logistic • Retained Earnings / Total Assets otherwise solvent.
function.
• EBIT / Total Assets
• Market Value of Equity / Total
Liabilities
Model Comparison: Accuracy and
Applicability
Model Accuracy Applicability Best Use
Altman Z-Score Medium Public Market and
manufacturing accounting data
firms available
Ohlson O-Score Medium Broad industries Large datasets,
logistic software
Zmijewski Model Low Public companies Simpler models
preferred
Springate Model Low Canadian SMEs Quick screening
with limited data
Logistic High All industries Custom models
Regression with large data
Model Accuracy and Industry Fit
Accuracy Ratings Applicability
• Altman Z-Score: 72%–80% • Altman: Public manufacturing
• Ohlson O-Score: ~85% • Ohlson: All industries
• Zmijewski Model: ~75% • Zmijewski: Public firms
• Springate Model: ~70% • Springate: SMEs, Canada
• Logistic Regression: >90% • Logistic Regression: Flexible, all industries
Impacts and Recommendations on Financial Distress
Models
Stakeholder Effects
Employees face job loss; creditors tighten credit; investors adjust strategies.
Credit & Stock Impact
Distress scores affect credit ratings and stock prices.
Regulatory Response
Models help regulators monitor systemic risk and enforce reforms.
Preventive Actions
Firms restructure, refinance, and use early-warning systems.
Key Takeaways
Models guide decisions but require context and updated data.
