BANKRUPTCY MODELS ENUNTIATION FOR CZECH GLASS MAKING FIRMS

BANKRUPTCY MODELS ENUNTIATION FOR CZECH GLASS MAKING FIRMS Jiri Klecka 1, Hana Scholleova 2 1 University of Economics, Prague, Czech Republic, jiri.klecka@vse.cz 2 University of Economics, Prague, Czech Republic, scholl@vse.cz Abstract Fall of glassworks in the CZ was presented as the first major impact of the financial crisis on the Czech enterprises, but their case is not so clear. It was a group of companies with traditional high-quality production, customers and good position in the market, but also long term operating business with significant financial problems. Management companies have long resembled a meeting of the financially illiterate - whether on payment of interest or other credit products to adjust the portfolio toward lower profitability. In connection with this, there are other questions: Were the creditors willing to accept the risk of bankruptcy, to which the company was coming closer and closer every year or did they see the potential, which cannot be measured by financial indicators that are focused on the historical financial statements? The aim of the article is to point to other consequences that could maintain the vitality in the glass making sector described above. The article should also highlight the limits of mentioned models even in the areas, where the firms don t by far appear in the so called grey zone. Keywords: Altman Index, IN05, bankruptcy. Introduction Shareholders and stakeholders focus on the firm s activity and try to predict the probable development with special focus on their interests. In order to achieve this, they use specific instruments and techniques, developed since 1960s. The economists from all over the world were trying to come up with certain models that would be able to predict the firm s future to the maximum possible rate of probability at least in the next few years. The first group of models emphasizes the more positive view - are prime models, which seeks to uncover a promising level of development e.g. Grünwald s prime model, Tamari s model or Kralicek s quick test (Marinič, 2008). The aim of the models above is the inclusion of the company into one of the groups that characterize the expected creditworthiness company. The second group of models seeks the reasons for fear of future developments; their goal is the prediction of impending bankruptcy firm. Among the best known and most used bankruptcy models is so-called Altman index developed gradually in several modifications. In the 1990s in the Czech Republic, virtually all banks formed their own models adapted to the Czech conditions, which were used for screening companies to provide credit. Models were private (rather secret), their success is discussible due to the problems banks had in 1997 in consequence of the large number of "bad" loans. In 1995, Inka and Ivan Neumaier began to create indices, which would be based on actual conditions of the Czech and thus spoke better about the state of Czech companies. These indices evaluate the business as a weighted average of several indicators of historical data based primarily on accounting statements and their last change (IN05) is of both the prime and the bankruptcy character. IN indices are used in practice unlike more complex models by the same authors (Neumaierová, 2009). The enunciation of these models is the topic of a number of business economy based discussions and analyses. The article focuses on the efficient use of chosen models for glass-making firms. These firms have experienced bankruptcy in the Czech Republic but according to the models described above this failure should have occurred much earlier. Characteristic of the set of enterprises Glass group of enterprises BOHEMIA CRYSTALEX TRADING Inc. is the most important Czech producer and exporter of domestic glassware and technical glass. With its production and business potential it belongs to prominent world glass organizations. Although Czech glass enterprises have got a long and famous tradition, in current deteriorating economic conditions they faced very serious problems which in year 2009 finally ended up with a complete terminating of production (which now, in year 2010, the new owner renews again). BOHEMIA CRYSTALEX TRADING Inc. is formed by enterprise CRYSTALEX Inc., Nový Bor, which is aimed on production of crystal glass, by enterprise Sklo Bohemia Inc., Světlá nad 954

Sázavou, producing lead crystal, by enterprise Sklárny BOHEMIA Inc., Poděbrady, producing lead crystal as well, and by enterprise SKLÁRNY KAVALIER Inc., Sázava, producing borosilicate glass. In which economic state did these enterprises start to face partly new and partly continuous and strengthening unfavourably acting factors? The analysis was performed on the basis of publically accessible financial economic data from years 2003 to 2006 from www.justice.cz. (Data in years 2007 and 2008 were published in limited measure.) For orientation examination of state of economy of these enterprises in years 2003 to 2006 three different solvent and bankruptcy models, originally developed as an instrument of evaluating solvency of a firm, used for example by banks during decision making whether provide a loan to an enterprise. Used bankruptcy and solvency models Altman model (Altman, 2006) was chosen for evaluating enterprises on one hand it is the eldest one and created for enterprises in the USA, but on the other hand its predicable ability about bankrupts is very good worldwide (Maňasová, 2007). In the light of regions of production s and markets location German Bonity index IB and Czech index IN05 will be used, then. Altman Z index (belonging to most often used ones worldwide) is investigated with a model constructed and lastly modified and updated by the method of discriminant analysis from an extensive set of data about enterprises. For enterprises which are not dealt on capital market, it has the form (1) Z = 3,3 EBIT / A + R / A + 0,6 E / D + 1,4 RE / A + 1,2 WC / A, (1) where EBIT is Earning before Interest and Tax A assets, R revenues, E equity capital, D debt, RE retained earnings, WC working capital. If Z< 1,81 a firm is not financially healthy and there is a high probability that it will go bankrupt in immediate 5 years; on the other hand over 2,99 it is concerned a completely financially healthy firm. A similar instrument of evaluation is Bonity index IB (Synek, 2009) commonly used in German speaking countries that created a great part of the target market of analysed companies. It is defined as IB = 1,53 CF / D + 0,08 A/ D + 10 EBT / A + 5 EBT / R + 0,3 INV / R + 0,1 R / A, (2) where CF is cash flow, EBT Earning before Tax, INV inventories, and other see above. Bonity index IB has got three control limits: situation of enterprises with s IB > 3 can be marked as extremely good, situation of enterprises with IB > 1 is good and enterprises whose IB < -2 are directly jeopardized by a bankrupt. Especially for the Czech Republic the index IN 05 was developed by Inka and Ivan Neumaier (Neumaierova, 2005) it has got a character of both bankruptcy and solvency model. The size of the index IN05 can be calculated as IN 05 = 0,13 A / D + 0,04 EBIT / IN + 3,97 EBIT / A + 0,21 R / A + 0,09 CA / STL, (3) where IN is interest, CA current assets, STL short-term liabilities, other see above. 955

If IN05 < 0,9, the enterprise with a high probability (86 %) moves towards bankrupt, on the contrary if IN05 > 1,6, the enterprise creates EVA (Economic Value Added) with a probability of 67 %. While calculating IN05 there is a problem - when the firm is clear of debts or very little indebted and the indicator of cost coverage is a huge number. For this case it is recommended while calculating IN05 to limit the value of the indicator EBIT /IN by the value in an amount of 9. A great contribution of solvency and bankruptcy models is their simplicity and removing subjectivity while choosing indices and their significance. The disadvantage is that while summarizing an enterprise s state into one number, information about causes of enterprise problems completely loose and therefore information about their removing as well. And application on the example of Czech glass-houses further shows that also the informational value of scoring models based on so called objective hard data can be limited. Application of bankruptcy and solvency models All three used model shown in all examined years in all these examined enterprises the results under the level of so called grey zone, which means bad results (as it can be seen on figures 1, 2, 3). Figure 1. Altman s Z-score Figure 2. Bonity index 956

Figure 3. Index IN05 From more detailed examination (see Table 1) it is obvious that the substantial factor of this unfavourable condition of enterprises was their continuously low return. Values of ROA universally do not even attain the risk free rate. Less the sufficient is the level of earnings after taxes regarding lawful requirements of shareholders. Therefore it does not happen even creating at least zero economic profit (EVA). It means that these enterprises did not heighten their value or if you like value of capital of their owners, on the contrary they systematically consummated it (EVA < 0). For this reason not only a possibility of creating and using internal resources was significantly limited, but so were the efficiency of using borrowed capital and the whole efficiency. Financial leverage took effect universally negatively (return of assets was continuously lower than cost of borrowed capital), therefore using borrowed capital did not wholly meet even appropriate interests. Financial leverage did not heighten profits, then, but it cut them and it resulted in another decrease in return which in connection with declining sales (except glass-house Kavalier) deteriorated the situation of all enterprises. Table 1. Financial indicators year 2003 2004 2005 2006 EBIT/Assets Crystalex -12,00% 0,51% 1,34% 0,04% Kavalier 2,23% 0,96% 1,05% 3,25% Bohemia 2,03% -1,56% -1,74% -1,70% Revenues/Assets Crystalex 0,76 0,64 0,67 0,63 Kavalier 0,77 0,76 0,79 0,75 Bohemia 0,76 0,78 0,83 0,84 Equity/Debt Crystalex 108% 126% 124% 111% Kavalier 101% 108% 113% 103% Bohemia 84% 88% 79% 71% Current Assets/Short-term liabilities Crystalex 1,39 1,40 1,41 1,36 Kavalier 1,15 1,20 1,26 1,22 Bohemia 0,89 0,87 0,85 0,83 957

Despite the predicted soon bankrupt, evaluated glass enterprises acted in the market up to years 2008 2009 when problems connected with decreasing demand weighed on them with decisive intensity. Problems to discussion offer themselves there: a) Why the firms did not get into troubles much earlier? b) Could models indicated deterioration coming from the change of enterprise s environment? c) Could the companies react early enough? Why the firms did not get into troubles much earlier? All used scoring models are indicative of fact that firms could get into troubles much earlier with a high probability, but they did not lose business partners despite of badly evaluated situation. It can be caused by a fact that used models work only with historical data of hard character whose ground is the internal accounting basis. For this reason information from participating markets cannot be caught up raw materials, labour, products, financial and so on, but neither business potential which the firm bears to the future. But the vitality of an enterprise is above all determined by factors of external (exogenous) environment of the enterprise that cannot be put down in enterprise s accounting. On the basis of internal analysis it is only possible to evaluate the enterprise in the light of past, present and rather short future, because factors of enterprise s external environment have got a decisive influence on long-term vitality of the enterprise (Synek, 2008). According to Harry Pollak (modified from quotations Pollak, 2003) an enterprise with a perspective is characterized by 1) optimal financial mix and operation which enable a sufficient evaluation of owners and creditors capital, 2) disposes with a stable constituency of satisfied customers, 3) it has got products appropriate to requirements of the market, it pursues the market and introduces new products, 4) it has got loyal, motivated and qualified employees, 5) reliable suppliers, 6) strategic location and a friendly relation to the environment. No matter the weight of particular factors it is obvious that only ad 1) is a question of internal processes of financial management, other factors of successful future are soft, not catchable in accounting, hardly measurable; and exactly in these factors there was a power that enabled firms to survive for a long time even in case of not very good internal results. All three used model shown in all examined years in all these examined enterprises the results under the level of so called grey zone, which means bad results (as it can be seen on figures 1, 2, 3). There were 1 169 firms, that have turned bankrupt in 2009, but in contrast to 2008 there were only small and middle firms (Dubská, 2010). All the glass firms with problems in 2008 experienced situations with little chance to survive. Their options depended on sufficient production. The firms have worked without financial reserves and each market swing was very hazardous. Four repeating problems of the Czech companies can be named (Kislingerova, 2009): 1) The firms didn t respond early enough, they started accepting active precaution only since 2009. 2) The system of risk management and evaluation is insufficient or possible signals are ignored. 3) Precaution to costs reduce are left far behind the need of savings. 4) Bad financial situation, high debts and very small reserves in cash flows. Unfortunately, it is important to note, that the collection of the companies described above have encountered all problems at once, being one of reasons why they didn t manage them well. Conclusion It is obvious from recognized values, but above all from construction of these models itself and then also from the character of reflection mediated by them, that these models could not predicate an actual crisis of these enterprises sufficiently in advance, which means to catch up quickly or even in advance those external stimuli which influenced enterprises with decisive intensity in year 2008 mainly the influence of suddenly decrease in demand and suddenly causes of this decline. Not even by deteriorating trend of indicated values. Concerning the influence of external factors, these models reflect right their consequences in economy and corporate finance, thereby such indication is practically effectual for needs of management of enterprise only in case of gradual incidence of these influences. 958

However, models could show in advance the bad financial condition and weakened immunity a longer time before the beginning of crisis and its quickly happened causes and consequences. These enterprises faced them with a not much strong economic and financial potential that was evident beforehand. References 1. E. I. Altman.(2006). Corporate Financial Distress and Bankruptcy. In Hobokem, John Wiley & Sons, New Persey. (pp 241) 2. Dubska, D. (2010). Podnikatelské prostředí a ekonomický růst ČR. In Czech Statistical Organization 192/2010-02. Praha. 3. Kislingerova, E. (2009). Podnik v časech krize. Praha: Grada Publishing. 4. Maňasova, Z. (2007). Úpadky podniků v české republice a možnosti jejich včasné predikce. In Praha. Dissertation thesis. 5. Marinič, P. (2008). Plánování a tvorba hodnoty firmy. Praha : Grada Publishing. 6. Neumaierova, I. & Neumaier, I. (2005). Index IN05. In: Evropské finanční systémy. (pp143-148) Brno : Masarykova univerzita. 7. Neumaierova, I. & Neumaier, I. (2008). Proč se ujal index IN a nikoli pyramidový systém ukazatelů INFA.. In: Ekonomika a management 3/2008. Praha: Vysoká škola ekonomická. 8. Pollak, H. (2003). Jak obnovit životaschopnost upadajících podniků. Praha: C. H. Beck. 9. Synek, M. (2008). Nová ekonomika nové ukazatele. In: Ekonomika a management 2/2008. Praha: Vysoká škola ekonomická. 10. Synek, M., & Kopkáně, H., & Kubálková, M. (2009). Manažerské výpočty a ekonomická analýza. Praha: C. H. Beck. 959