Analysis of Current Ratio and Net Profit Margin to Predict Company's Financial Distress Conditions

Dematria Pringgabayu¹, Raden Aswin Rahadi², Kurnia Fajar Afgani², Liane Okdinawati² and Claudia Christananda³

¹Program Studi Keuangan dan Perbankan, Politeknik Pajajaran ICB, Bandung, Indonesia

²Sekolah Bisnis dan Manajemen, Institut Teknologi Bandung, Indonesia

³Universitas Padjadjaran, Bandung, Indonesia

INTRODUCTION

Capital Market is a market for a variety of long-term financial instruments that can be traded, whether it is debt (bonds), equity (shares), mutual funds, derivative instruments, and other instruments. Capital market is a means of funding for companies and other institutions (e.g. government), and as a means for investing activities. Thus, the capital market facilitates various facilities and infrastructures of buying and selling activities and other related activities. Financial instruments traded on capital markets are long-term instruments (more than 1-year term) such as stocks, bonds, warrants, right, mutual funds, and various derivative instruments such as options, futures, and others (www.idx.co.id).

According to (Yuanita, I. 2012) in 2013, Most companies in the textile and garment industry experienced a tendency to decline in net income and even suffered losses. This suggests that companies are less likely to make a profit. If this situation is continuous, then the business continuity will be interrupted, because the profits obtained by the company can finance the operation of the company, return the loan, and other obligations to be fulfilled. One of the causes of falling profit is due to declining sales. These conditions will eventually exacerbate the state of the unsealed textile and garment company will likely have financial difficulties, even failure in its efforts. However, it was previously known that the industrial sector has enough of a good market share in the country.

Financial statements are one of the references for investors to see the performance of a company. Therefore, the company should anticipate some of the worst possibilities. Some of the companies have been bankrupt because the company did not identify the signs of Financial Distress. The company must know the symptoms of Financial Distress since early. Financial statements and financial ratios are related to each other, so to understand the Financial Distress symptom of financial ratio calculation is required. There is anyway method of the Altman Z-score which determines the ratio of which affects the Financial Distress. Companies that experience financial distress are relatively not considering the financial ratios of the company's report to predict the company's financial Distress condition since early.

In 2018 Textile and garment companies experienced a decrease in performance with the presence of several companies that did the deletion of the records (delisting) from the list of Indonesia stock Exchange due to bankruptcy. Listed from 20IDX-listed textile and garment companies, three companies are delisting due to the condition that significantly affects the negative in its financial and operational performance and does not have any more income. Therefore, it is necessary to review the prediction of financial condition Distress of Textile and garment company listed on the Indonesia Stock Exchange.

Based on the previous explanation, this research tried to answer the following questions:

1. How is the influence of the Current ratio, Net Profit Margin, and Altman Z-score on textile and garment companies listed on the Indonesia Stock Exchange in the period 2013-2018?

2. Does the Current ratio and Net Profit Margin simultaneously influence the Altman Z-score of the textile and garment companies listed on the Indonesia Stock Exchange for the period 2013-2018?

3. Is the Current ratio partially influential to the Altman Z-score on textile and garment companies listed on the Indonesia Stock Exchange period 2013-2018?

4. Does the Net Profit Margin partially influence the Altman Z-score on textile and garment companies listed on the Indonesia Stock Exchange in the period 2013-2018?

LITERATURE REVIEW:

Previous Studies:

Financial Report Analysis:

According to (Irfan, M. 2014) analysis of financial statements is one form of assessment of the ability of the company in conducting its operational activities, which is reflected in the financial statements. The financial statement is evaluated to obtained information about financial performance in the past, present, and possible in the future. Meanwhile, (Irfan, M. (2014) state the analysis of financial statements is used to determine the level of profitability and the level of risk or health of a company. Besides, the analysis of financial statements can be used to analyze the financial position to predict the trend of financial statements in the future. It can be used to know the relationship between a company and other companies both in one financial report and between financial statements.

Financial Ratios analysis:

Financial Ratio analysis is a method of calculation and interpretation of financial ratios to assess the performance and status of an enterprise. Therefore, the analyzer must be able to customize the factors that exist in this period with future factors that may affect the financial position or the results of the company's operations in question. According to (Kasmir, 2014), explaining the financial ratios is the activity of comparing the numbers in the financial statements by dividing a number by the other number. According to (Harahap, S. S. 2011), the financial ratios are the numbers derived from the comparison of one account of the financial statement with other accounts that have a significant and relevant relationship.

Types of Financial Ratios Analysis:

In financial ratio analysis, it is necessary to calculate financial ratios that reflect aspects. Financial ratios are calculated based on the numbers in the balance sheet or income statement. The ratio is made according to the needs of the analyzer.

According to (Harahap, S. S. 2011), the types of financial ratios are as follows:

1. Liquidity Ratio This ratio illustrates the company's ability to pay off short-term obligations.

2. The solvency ratio describes the company's ability to pay off its long-term obligations or obligations when the company is liquidated.

3. Profitability or Profitability ratio illustrates the company's ability to utilize existing resources (HR, capital, cash) to generate profits for the company.

4. Leverage Ratio describes the company's debt to assets or capital. This ratio is used to see the extent to which a company's ability is financed by debt when compared to the company's ability when viewed with its capital or equity.

5. Activity Ratio describes the company's ability to carry out its operations such as sales, purchasing, and other activities.

6. Growth Ratio describes growth percentage from year to year.

7. Market valuation describes the situation/state of the company's achievements in the capital market.

8. The productivity ratio shows the level of productivity of the unit or activity assessed by assessing the productivity of the units.

Financial Distress:

Platt and Platt in (Hanafi, M. M., & Halim, A. 2005) defines Financial Distress is a condition where the company's finances are in an unhealthy condition or crisis. According to (Hanafi, M. M., & Halim, A. 2005), Financial Distress can be defined in several senses, namely:

1. Economic Distressed:

Failure in the economy means that the company loses money or the company's income cannot cover its costs, this means the profit rate is less than the cost of capital, or the present value of the company's cash flow is less than the liability. Failure occurs when the actual cash flow of the company is far below the expected cash flow.

2. Financial Distressed:

Understanding Financial Distressed has the meaning of funding difficulties both in terms of funds in the sense of cash or the sense of working capital. As asset-liability management, it plays a critical role in regulating to avoid being affected by Financial Distressed.

(Sudana, I. 2011) states that the causes of financial distress are caused by economic factors, errors in management, and natural disasters. Companies that fail in operation will have an impact on financial difficulties. But most of the causes of Financial Distress either directly or indirectly are due to management mistakes that occur repeatedly.

Altman Z-Score:

Edward I Altman was a researcher who discovered the first Z-Score analysis model. The method of analysis is also known as Multiple Discriminant Analysis (MDA). The method is used by Altman to measure the coefficient of independent variables to predict the possibility of bankruptcy in a company. However, the first Altman analysis model can only be applied to companies engaged in large-scale public manufacturing (Irfan, M. 2014).

According to (Toto, P. 2011) Along with the times, and changes in economic conditions, and market behavior, then Altman modified the bankruptcy analysis model again. In this Z-Score model, Altman eliminates the Sales / TA variable, which is the ratio of sales to total assets and changes the coefficient value of all variables used in predicting bankruptcy in a company. The formula of the analysis model is:

Z = 6,56 (WC/TA) + 3,26(RE/TA) + 6,72(EBIT/TA) + 1,05(BVE/BVD)

Description:

The Z-Sscore model results in a lower average score for the group of companies that is bankrupt compared to the second bankruptcy model. To predict whether a company in developing countries has the potential for bankruptcy or not, then Altman also set discriminant areas. This condition can be seen from the value on Z-Score

If:

• For the value of Z-Score <1.1 means the company is experiencing financial difficulties and high risk.

• For Z-scores of between 1.1 and 2.60, the company is in a vulnerable area. In this condition, the company is experiencing financial problems and must be anticipated immediately by making decisions by the right and right management. If it is too late in deciding, the company can go bankrupt.

• For the value of Z-Score> 2.60 states that the financial condition of the company is in a very healthy condition so that the possibility of bankruptcy is minimal.

Data Analysis and Hypothesis Testing Techniques:

This study uses a quantitative approach. In general, according to Daniel Muji's in (Suharsaputra, U. 2012), quantitative research methods are research methods intended to explain phenomena using numerical data, then analyzed which generally use statistics. Meanwhile, the analysis tool used by the author in this study is multiple linear regression analysis.

In this study, the authors used a multiple linear regression analysis tools used to see the effect of the independent variables on the dependent variable, namely the current ratio and net profit margin on Financial Distress. The data is processed with the help of SPSS software version 22.0.

In this case, there are two independent variables and one dependent variable. Thus, multiple linear regression is expressed in mathematical equations as follows:

Y = a + b₁ X₁ + b₂ X₂ + e

Where:

Framework:

Companies that experience financial distress or Financial Distress can result in bankruptcy. Prediction of Financial Distress in a company can be made through the analysis of the company's financial statements. Test one by one financial ratio and categorize whether these ratios have a positive or negative effect and are significant or not significant to the company's Financial Distress conditions. This can also be proven by calculations using the Altman Z-Score model that can predict the presence or absence of Financial Distress in a company. Some ratios that can be used in predicting a company's Financial Distress include liquidity ratios and profitability ratios.

This ratio will be used by the author to prove whether this ratio can predict a company's Financial Distress and it is expected that this ratio will have a negative effect on a company's Financial Distress where if other variables are assumed to be constant, an increase in net income to sales will reduce the risk of the company's Financial Distress.

Based on the explanation above, the framework of thought in this study can be described as follows:

Image is available at PDF file

Figure 1: Framework for Thinking

RESEARCH METHODOLOGY:

Research Characteristics:

According to (Sekaran, U. 2012), research is a process of finding solutions to problems after conducting in-depth studies and analyzing solution factors. This research uses quantitative methods, with descriptive and verification research objective categories.

The characteristics in this study are illustrated in the following table 1:

Table 1: Research Characteristics

Source: Author’s Analysis, 2021

Data Collection Tool:

Variable Operasional:

In this study, researchers wanted to know the effect of independent variables (independent variables) and dependent variables (dependent variables) in casual relationships, which means that a variable will affect other variables in a causal relationship (Hasibuan, S. P. 2010). The variables studied can be divided into two:

1. Independent Variable (Free):

The independent variable according to (Amos, N. 2014), is a variable that is influenced by other variables, whereas according to (Kurniawan, A. 2012) the independent variable is the variable that is the cause of change or the emergence of the dependent variable (bound). It is known as an independent variable, meaning that it affects other variables. In this study, the independent variables used by the authors are as follows:

1. Current ratio (X₁)

2. Net Profit Margin (X₂)

2. Dependent Variable (Bound):

The dependent variable (Y) in this study is the Financial Distress which is measured using the Altman Z-score calculation. Financial distress in this study is called the binary variable. Binary variables are variables that are categorized with 0 for healthy companies and 1 for companies that experience Financial Distress. A company is said to experience Financial Distress if within a few years it suffers a negative net profit.

Population and Samples:

Research Population:

In this study, the authors determine the Manufacturing and Textile sub-sector Manufacturing companies listed on the Indonesia Stock Exchange (IDX) from 2013 to 2018. There are 17 (Seventeen) textile and garment companies in this study population, namely listed companies listed on the Stock Exchange Indonesia (IDX). From this population, several samples were taken as the object of research studies.

Research Samples:

The sampling criteria in this study include the following:

1. The research population is the textile and garment sub-sector manufacturing industry registered on the Indonesia Stock Exchange in the 2013-2018 period.

2. Textile and garment sub-sector manufacturing companies that consistently publish audited financial statements for the 2013-2018 period.

Data Collection and Data Sources:

In this study, the authors use secondary data. The data used by the author in this study is the financial statements of each object of study, i.e.:

1. Company Profile Data

2. Income Statement

3. The balance sheet of financial statements

The company list for this research is as follows:

RESULTS AND DISCUSSIONS:

Descriptive Statistics of Research Variables:

The variables in this study consisted of the dependent and independent variables. This study uses Financial Distress as the dependent variable, while the independent variables used are the current ratio and net profit margin. The table below presents the 13 companies examined in this study that include mean, maximum, minimum, and standard deviation. Descriptive statistical test results for the current ratio are presented in table 2 below:

Table 2: 2013-2018 Descriptive Statistics Calculation Results

Source: Author’s Analysis, 2021

Based on Table 2 it can be explained that during the study period, the average variable current ratio (X1) for the period 2013 - 2018 from 13 companies, which amounted to 109%. For the smallest current ratio, experienced by PT. Indo-Rama Synthetics, Tbk (INDR) in 2017 which is 4%, this means that PT. Indo-Rama Synthetics, Tbk decreased in 2017, with current assets of Rp. 11,264,831.00 and total current liabilities of Rp. 281,571,764.00 which is caused by a decrease in sales in the year, then for the most significant current ratio experienced by PT. Pan Brothers, Tbk (PBRX) in 2017, amounting to 382%. The current ratio is a ratio to measure how much cash is available to pay debts. This is indicated by the availability of cash funds or cash equivalents such as checking accounts—the higher the ratio of cash or cash equivalents to current debt, the better.

Then the average net profit margin (X2) variable for the period 2013 - 2018 from 13 companies, which is -12%—for the smallest net profit margin, experienced by PT. Argo Pantes, Tbk (ARGO) in 2017 that is equal to -0.0032%, this means that PT. Argo Pantes, Tbk has decreased its ability to generate profits in 2017, with net income of (Rp33,054,946.00) and total net sales of Rp104,819,253.00 due to several internal and external factors in the year, then for net profit the largest margin experienced by PT. Eratex Djaja, Tbk (ERTX) in 2014, amounting to 13%. The greater the NPM, the company's performance will be more productive so that it will increase investor confidence to invest in the company. This ratio shows how much percentage of net profit obtained from each sale. The greater this ratio, the better the company's ability to get high profits is considered. The relationship between net income and net sales shows management's ability to run the company successfully enough to leave certain margins as reasonable compensation for owners who have provided their capital for risk. Capital market investors need to know the company's ability to generate profits.

Finally, based on table 4.1 it can be explained that during the study period, the average Financial Distress (X3) variable assessed through the Altman Z-score for the period 2013 - 2018 from 13 companies, amounting to -0,176. The smallest Financial Distress experienced by POLY in 2018 amounted to -27,911. This means that POLY is most vulnerable to bankruptcy, failure, insolvency, inability to pay off debt, and default. For the largest Financial Distress owned by TFCO in 2018, that is 11,037, which shows that TFCO is the healthiest company so that the possibility of bankruptcy is minimal. POLY has the smallest z-score Altman value, because the value of working capital is (Rp10,096,346,473,644.00) while the total value of its assets is Rp3,988,442,112,390.00

Descriptive Analysis of Current ratio:

In this study, researchers used annual financial reports from 13 companies, using the current ratio formula.

Table 3: Descriptive Statistics of Variables Current Ratio (in percent)

Source: Author’s Analysis, 2021

Based on Table 3 it can be explained that during the study period, during 2013-215, the smallest current ratio value of the 13 companies (min) occurred in 2017 which was 4% experienced by PT. Indorama Synthetics Tbk. In 2013 PT. Pan Brothers Tbk. Able to record the most significant current ratio value (max) of the entire company in this study, the corporation was able to record that value of 382.2%. The average (mean) value of the current ratio of the whole company during 2013-2018 showed a relatively stable change. However, the average current ratio jumped dramatically in 2015, the average current ratio of 118.4%. The average current ratio in 2016 was 99%, wherein 2017 there was no significant increase by only giving an average value of 108.5%. The average current ratio in 2015 was not too much different from what happened in previous years. The average current ratio in 2015 was only 1.18%. In 2017 the average current ratio was 0.97%, which is followed by a decrease of 0.67% in 2018 by 0.30 points.

Descriptive Net Profit Margin:

In this study, researchers used annual financial reports from 13 companies, using the current ratio formula.

Table 4: Descriptive Statistics of Net Profit Margin Variables (in percent)

Source: Author’s Analysis, 2021

Based on table 4 it can be explained that during the study period, during 2013-2018 the smallest Net Profit Margin value of the 13 companies (min) occurred in 2017, amounting to -3875.89% experienced by PT. Indorama Synthetics Tbk. In 2017 PT. Eratex Djaja Tbk. able to record the largest Net Profit Margin (max) value of all companies in this study, the corporation was able to record the value of 28.08%. The average (mean) Net Profit Margin value of the entire company during 2013-2018 shows a declining trend, which based on the table presented above indicates that in 2017 there was a drastic decrease in Net Profit Margin of -303.20%. The average Net Profit Margin in 2016 was 0.07%, wherein in 2017 it continued to decrease to 0.00%. This downward trend continued to be experienced in 2012 and 2016 in which both Net Profit Margin values ​​were -0.02%. The decline in the value of the Net Profit Margin in 2017 experienced a drastic depreciation compared to previous years, which is what is presented in the table above the average Net Profit Margin value of -303.20%. The average Net Profit Margin value of the entire company in 2018 also showed a decrease when compared to previous years, wherein 2018, the Net Profit Margin value was -6.30%.

Descriptive Financial Distress:

Financial distress is a broad concept that consists of several situations where a company faces financial difficulties. Common terms to describe the situation are bankruptcy, failure, insolvency, inability to pay off debt, and default. Insolvency in bankruptcy shows negative net worth. The inability to pay off debt shows a negative performance and shows a liquidity problem. Negligence means a company violates agreements with creditors and can lead to legal action.