Argentis A Score and Altmans Z Score Models - Essay Example

of the of the Concerned 12 April 2009 Argenti's 'A' Score and Altman's 'Z' Score Models Simply speaking, a corporate failure may be defined as a situation when a company goes bankrupt and is thus forced to quit its business activities. Off course it is quiet obvious that any corporate concern goes out of business only if it fails on some fundamental parameters. Thus, corporate failure analysis constitutes and integral part of the contemporary business scenario. Hence the aim of any pragmatic corporate failure analysis is to identify the tell tale symptoms that are discernibly indicative of the fact that a company is heading towards annihilation. Such an analysis enables the management, administration, financial institutions and creditors to strive for and press on the need for introducing the apt countermeasures in advance so as to avert any possibility of a pending corporate failure. Till date, the concept of corporate failure analysis is predominated by two diverse approaches, one of which is purely quantitative whereas the other is thoroughly qualitative in its scope. If one holds that most of the corporate failures can be attributed to financial lapses, then it is certainly possible to avert any corporate failure by resorting to a timely and apt financial analysis. On the contrary there exists one other approach that believes that most of the corporate failures are caused by non-financial lapses and irregularities and financial irregularities in any company are a mere side effect of the discrepancies existing in the qualitative aspects of business. In the light of the given discussion, Altman's 'Z' Score model is a noteworthy quantitative approach towards corporate failure analysis, whereas Argenti's 'A' Score model definitely stands to be its consummate qualitative counterpart. Altman's Z-score model is an important performance management and company failure analysis tool. Also known as Altman's Bankruptcy Predictor, this model was given by Edward I. Altman in 1968, who worked as a professor of finance at the New York University (Calandro 2007, p.37). This model is primarily a statistical formula that can be exploited to predict corporate performance. The basic strategy behind this model is that it depends for its validity on a series of chosen financial ratios and each and every selected key ratio is assigned a weighting. The Z score derived through the incorporation of the key ratios in the mathematical formulas is used to predict whether a company is liable to fail or not. The Z score calculated through a detailed data analysis is eventually used to predict the sustainability of a company. In case this Z score surpasses a specific figure, the company being analyzed is considered to be safe. A Z score of above 3 is considered to be healthy and safe while a score lying around 1.8-3 is regarded as being precarious. Thus Altman's Z score model is to a great extent dependent on the data culled out from a company's published financial statements and its reliance on the qualitative aspects of business is almost negligible Advantages of Z score model are: This model is considered to be highly accurate. In more then 72% of the cases, it has been found to successfully predict corporate bankruptcy. It is easy to calculate. This model can be used to complement other analytical tools. This model enables the analysts to incorporate many financial characteristics within a single score. The Disadvantages of Z score model are: It focuses only on financial data. Z score does not help the management to understand the dynamics of the problems existing in the company. The results may turnout out to be inaccurate in case of a corruption of the financial data. It is not useful for predicting company failure in the current scenario as it is based on out of date assumptions and data (Grice 2001, p.57). Its results do not stand to be that accurate in case of non-manufacturing firms (Grice 2001, p.57). It is highly generalized in its approach. The values of some quantitative ratios used in this model are prone to change from time to time. Argenti's 'A' score model is a purely qualitative approach towards corporate failure analysis. Thus it has a minimal reliance on the information contained in the published financial statements. Like Z score, this model furnishes a score called the A score that can be used to profess or predict the possibilities of insolvency in small and medium sized companies. The greater the A score of a company, the more is it liable to fail. An A score of 0 is considered to be an ideal situation (Fight 2008, pp.229). A company having an A score of 25 is the one most liable to fail (Fight 2008, pp.229). An A score of 18-25 is regarded as being in the grey zone (Fight 2008, pp.229). Argenti's 'A' score model also assigns specific weighting to certain qualitative entities, which are grouped under three headings: Defects - These traits include the defects and discrepancies that are rampant within an organization and its administrative structure (Woolf 2007, pp.399). Ex., an overbearing CEO, unrealistic budgetary allocations, poor organizational communication, etc. Mistakes - This includes the avoidable factors that can jeopardize the sustainability of a company (Woolf 2007, pp.399). Ex., over borrowing, embarking on non-feasible ventures, etc. Symptoms - These factors are conclusively indicative of the fact that a gross deterioration has set within a company (Woolf 2007, pp.399). Ex., unaccounted for losses, demoralized staff, etc. The advantage of Argenti's 'A' score model is: This model covers a wide range of financial and non-financial indicators (Woolf 2007, pp.399). It gives the management an insight into the possible causes underlying the company failure. It is flexible in its approach. This model is sensitive towards the concerns of customers, stock holders and employees. The disadvantages of this model are: This model is utterly subjective in its approach and is always open to diverse interpretations. Some of the qualitative entities used in this model are mostly confidential in nature and hence cannot be freely disclosed (Fight 2008, pp.229). This model is usually successful with only small and medium sized companies (Fight 2008, pp.229). An effective economic decision making in any organization needs to take a pragmatic stock of all the vital quantitative and qualitative factors. In that sense, both the above mentioned models complement each other. Z score model is certainly effective so far as predicting the financial health of a company is concerned (Twenty-Third Floor 2008, pp.5). But, an effective turnaround strategy in an ailing company does needs to take into account the qualitative factors also (Twenty-Third Floor 2008, pp.5). Not doing so may lead to a debilitating neglect of many key areas. Hence any commonsensical corporate failure analysis makes it mandatory to exploit both the quantitative and qualitative approaches to get a complete picture of the real situation. Total Words: 1,150 Works Cited Calandro Jr. Joseph 2007, 'Considering the utility of Altman's Z-score as a strategic assessment and performance management tool', Strategy and Leadership, Vol.35, Issue-5, pp.37-43. 'Don't use the Z-score to manage a turnaround', Twenty Third Floor, viewed 12 April 2009, Read More