Predicting Financial Distress in Commercial Banks in Kenya.

Abstract

The objectives of this study were to develop a discriminant model incorporating ratio stability that can be used to predict financial distress in Commercial Banks in Kenya and to identify critical financial ratios with significant predictive ability. The following ratios were identified as significant. Net Profit / Sales, Net profit / total Assets, Current Debt/Inventory and Total Debt/Total Assets. The findings provide evidence that the stability of financial ratios has an impact on the ability of the firm to continue as a going concern. Profitability ratios offer a reasonable measure of management effectiveness in firm value creation, leverage / indebtedness ratios provide historical reasons for firm failure while liquidity ratios constitute a measure of firms’ solvency. An important observation is that none of the Activity and Turnover ratio was found to be critical in predicting financial distress in commercial banks in Kenya failure prediction. The model attained 70% and 100% correct classification in year 1 and in year 3 respectively. The findings are consistent with studies by Kiragu (1991), Kiege (1991) and Dambolena and Khoury (1980) who concluded that profitability and leverage ratios were crucial in predicting failure. The findings however differ with those of Altman’s (1968) who concluded that efficiency and profitability ratios were most crucial and that liquidity ratios were not significant. The methodology utilized examined and justified the research design to be applied in the study. It also stated the population of interest for the study and the sample to be used. The data collection method that was used was provided. The data analysis technique to be applied and the justification for its use is also given. The computer software for analyzing the data was provided as well as what was used for presenting the findings. Finally, the model derived checked and validated.