RELATIONSHIP BETWEEN LEVEL OF PROSPERITY AND FAILURE PREDICTION

Abstract

The manufacturing industry plays in almost every economy a key role. One of the newest and most accurate model for prediction of financial stability is Karas & Reznakova´s Index. This model was made in the Czech Republic on the dataset of Czech manufacturing companies in 2014. It is able to predict distress or financial stability with high probability, although it is unclear how the relationship to corporate performance is, primarily, what is the interconnection to return on equity (ROE). In order to find this answer, a research was carried out including near 900 companies operating in the manufacturing industry. The goal was to confirm or disprove interdependence between ROE values to individual rating grades of Karas & Reznakova´s Index (K&R Index). The authors of this article consider the information whether the company goes bankrupt or not, as inadequate. Study has shown that the risk categories with a probability of bankruptcy of 1.10% or less achieve an average ROE from 10.30% to 13.63%, and that the probability of a negative ROE is only 11.62% for these categories. Unfortunately the study demonstrated no statistically significant linkage between the value of K&R Index and the prosperity of the business in the following year expressed by ROE values. Despite that now the analysts using K&R Index have a clearer view on the future prosperity development of a company.