Question 1 - Effectiveness of Altman or Modified Altman Algorithm
Today, the pressures from globalization and global competitiveness have been increasing consistently in a dramatic manner. In their true essence, business activities are undertaken to work towards generation of profits and achievement of growth objectives by serving targeted consumers in an effective manner. With increased volatility in the global business environment, it has become imperative to assess if a business or any organization is performing well or not. Analysts predict whether the business will go bankrupt has become one of the greatest concerns of various financial analysis theories and researches.
Additionally, it has been widely believed among financial research analysts that ratios are most suitable metric to make a financial performance analysis of any business. This is so because researchers considers both, the financial ratio analysis and Altman's Z-Score or modified Z-Score algorithm, simple due to their prediction capabilities. Comparatively, it has been concluded that the financial ratio analysis of operational data proves to be a very authentic and useful tool for comparing high performing firms with failed ones.
The Altman's Z-Score resembles a credit-strength test attempting to measure the creditworthiness and likelihood of bankruptcy of any business, particularly the publicly traded manufacturing company . The Altman Z-Score and the related modified algorithm are mainly based on five ratios calculated from the financial data found in a publicly traded company's annual 10K report . The Altman Z-Score and the modified algorithm are calculated in the following manner:
Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
Where:
A = Working Capital divided by Total Assets
B = Retained Earnings divided by Total Assets
C = Earnings before Interest & Taxes (EBIT) divided by Total Assets
D = Market Value of Equity divided by Total Liabilities
E = Sales divided by Total Assets
A Z-Score below 1.8 reflects that the company under review is far more vulnerable to go bankrupt, while businesses with Z-Scores more than 3.0 are less likely to become bankrupt. Therefore, the higher Z-Score depicts lower likelihood of going bankrupt or in financial distress . Investors willing to extend financial support to any business can utilize Altman Z-Scores to analyze whether they should trade (like buy and sell) in a particular company’s stock depending upon the businesses financial strength as well as performance overtime. The modified Altman Z-Score algorithm can also be used in the same way to evaluate credit risk of any business under review (both public and private manufacturing as well as non-manufacturing).
Depending upon the discussion made in this section, a keen observer can arrive at a decision that Altman Z-Score and his modified algorithm are an integral part of an effective management performance measurement system. This is so because the financial ratio analysis attempts to measure the ability of any business (private or public and manufacturing or non-manufacturing) to generate profits, manage its liquidity and escape the negativities of bankruptcy and financial distress depending upon the Z-Score.
However, there is a recommendation that the five ratios calculated to form a Z-Score should consider the involvement of liquidity ratios like current and quick ratios because they measure the short-term liquidity strength of the business. Moreover, the metric should also consider the interest coverage ratio which is important creditors to analyze if the business is able to cover fixed interest obligations or not. Higher ratio means the business has strong liquidity position when numbers are compared against any given global standard or benchmark. These ratios measure the ability of a company under review to provide a margin of safety to short-term creditors (investors) and lower its default risk.
Question 2 – Importance of Strassmann’s Knowledge Management Metric
Since many decades, economists, intelligent professionals and other policymakers have been concerned about creation, acquisition and communication of knowledge, its management as well as bring improvement in its knowledge re-utilization. The complex business environment, dictated by the stringent competition and globalization pressures in the global market, has caused many businesses to introduce numerous changes in their current business operational activities to survive in the worldwide marketplace .
In light of this change, there has been a strong urge or drive for businesses to shift from the utilization of traditional performance management metrics in an attempt to follow the knowledge-based economy where the intangible resources are abundant enough for enabling businesses to add more to the stakeholder value. In this regard, Strassmann and Drucker introduced the Knowledge Management metric stressing heavily on the emerging importance of information and knowledge management as one of the prime organizational resources . Many successful organizations showed their great interest when the Knowledge Management metric was introduced with capabilities to gauge the financial and non-financial performance efficiently.
Strassmann’s Knowledge Management metric has become a prime focus of human resource managers because it considers two broad concepts of intangible assets like Personal Knowledge Capital (PKC) (which reflects true worth of an employee in the market) and Corporate Knowledge Capital (CKC) (which reflects corporate earnings made available to shareholders). This metric is important to human resource managers because it helps them to link salaries which are paid to employees to the market worth.
If PKC is greater than CKC, it means that the business is unable to pay its employees their market worth which motivates the employee turnover to increase in a dramatic manner. Similarly, if employees switch to other businesses to get a higher pay, this activity will reduce their market worth. Strassmann’s metric is also important to appreciate the hard-work and high performing employees.
In companies where PKC supports CKC (the former is less than the latter), this reflects that employees seems to be happy with their job and acquire more knowledge for their application at work to remain competitive. In this situation, it becomes necessary that employees must be appreciated for their work to keep them motivated to remain highly productivity at work.
Depending on this capability, one may say that the Strassmann’s Knowledge Management metric is really very of prime importance to every business because it helps to monitor employee market worth and to keep compensation in line with such worth which keeps most of the employees highly productivity at work, thereby, reducing the cost of employee turnover .
References
Graham, A. (2000). Corporate Credit Analysis: Credit Risk Management. Global Professional Publishing.
Guerard, J. B., & Schwartz, E. (2007). Quantitative Corporate Finance. Springer Science & Business Media.
Harrington, J. H., & Voehl, F. (2006). Knowledge Management Excellence: The Art of Excelling in Knowledge Management. Paton Professional.
Jelenic, D. (2011). The Importance of KnowledgeManagement in Organizations – with Emphasis on the Balanced Scorecard Learning and Growth Perspective. Management, Knowledge and Learning International Conference, (pp. 33-43).
Osei-Owusu, M. (2013). Is Strassmann's 'Knowledge Management' an Important Metric. Social Science Research Network (SSRN) .
Wahlen, J., Baginski, S., & Bradshaw, M. (2010). Financial Reporting, Financial Statement Analysis and Valuation: A Strategic Perspective. Cengage Learning.
