A New Index Score for the Assessment of Firm Financial Risks

A New Index Score for the Assessment of Firm Financial Risks

19/04

Mehmet Selman Çolak

English

February 2019

There are several indicators and univariate ratios that measure the soundness of firms' balance sheets (Leverage, profitability, liquidity ratio, etc.). However, each indicator alone cannot measure the overall financial risk or the financial distress level of firms. In this study, we measure the financial strength of the real sector firms quoted in Borsa Istanbul (BIST) by producing a composite index score which is a combination of several different corporate finance ratios. In the first part, we will apply multiple discriminant analysis to the variables used in Altman Z-score (1968), which is the most prevalent composite index score measuring the firms’ financial risks in the literature. In the second part, a new index, named as MFA-score (Multivariate Firm Assessment Score) will be introduced by using the ratios that best explain the characteristics of the BIST companies. Both the tailored version of Altman Z-score and our new index score have a predictive power around 90 percent. Furthermore, MFA-score is capable of detecting the impact of macro-economic developments on firm balance sheets, which enables us to use MFA-score as an early warning indicator of financial distress for Turkish firms. Our analyses with MFA-score suggest that non-exporter firms and firms with FX open position have relatively weaker balance sheets.

Balance sheets, Financial risk, Altman Z-score, Multiple discriminant analysis, Financial distress, MFA-score

G30; G33; C18; C43