The effects of performance ratios in predicting corporate bankruptcy: The Italian case

Abstract

Corporate failure prediction is a mayor issue in today’s economy. Any prediction technique must be reliable (good recognition rate, sensitivity and specificity), robust and able to give predictions with a sufficient time lag to allow for corrective actions. In this paper we have considered the case of Small-Medium Enterprises (SMEs) in Italy trying to determine which dimension, in terms of performance indicators, best suits this goal. We have considered three of the most robust and diffused classification techniques on data over a period of 8 years prior to failure. The results tend to suggest that, for the Italian SME system, profitability ratios are always relevant in predicting corporate failure (both in the short and in the medium-long run), while leverage and liquidity indicators, affecting the financial dimension of the company, tend to add information in predicting a possible risk of default only in the medium-long run.