What is Bankruptcy Prediction?

Bankruptcy prediction is the strategy of properly interpreting available data in a manner that accurately projects the potential of a given firm to eventually file for bankruptcy protection. The process normally involves the collection and assimilation of large amounts of information that has to do with both the company and the industry where if functions in general. Many lenders make use of this type of projection in order to determine if a given business is a good credit risk.

There are several types of information that go into providing the basic building blocks for any bankruptcy prediction. First, the current financial condition of the operation is extremely important. A business that is not able to meet present obligations is likely to be seen as a greater risk for bankruptcy at some future point, while a business that is current in its obligations is likely to be viewed with more favor. Even if the profit margins are somewhat slim, a business that is operating with low overhead, relatively little debt, and demonstrates all the earmarks of being sound from a financial and operational standpoint is likely to be considered a relatively low risk for bankruptcy.

Along with the circumstances of the business operation, lenders will also look closely at developing trends within the industry associated with that company. If there are indications that the industry is likely to undergo some type of slump within the next several years, a lender may view this as an increased potential for bankruptcy to occur. This is true even if the business is currently financially sound. By projecting the most likely response to shifts in the industry by the company applying for a line of credit or a loan, it is possible to develop an informed bankruptcy prediction, and determine if the level of risk to the lender is within an acceptable range.

Bankruptcy prediction can also be a helpful tool for a business operation. By using criteria similar to what is used by lenders, it is possible to determine if the business is moving in a direction where the potential for bankruptcy increases. Analyzing the data used to make the prediction can help the company develop new operational strategies that minimize the potential for bankruptcy, and ultimately allow the business to remain profitable over the long-term.

Today, the process of bankruptcy prediction is aided with the use of modern technology. Data that would have taken weeks or even months to assemble can now be collected in a matter of hours or days. General information on specific industries can also be collected and updated on a continual basis, which helps to shorten the assessment period even more. Much of the data required to make an informed bankruptcy prediction can be obtained online with relatively little effort. In addition, software programs are available today that make it possible to sort the collected data with relative ease, allowing the lender to provide a quick response to the approval or rejection of a loan application.