Risk of Business Bankruptcy: The Application of DEA Method – Case Study of Slovak Businesses

Financial Health Of The Company And The Process Of Its Failure

When focusing on health of the company, we must take into account all of its health issues. The company is perceived as “healthy” when it achieves a positive equity value, positive cash flow and positive economic result (Juárez, 2011).

In the early stages of a company's financial problems, the company fails to meet its liabilities, and this situation escalates into financial difficulties. These will subsequently result in the failure of the company, which means that the achieved rate of return on invested capital, taking into account the risk, is significantly lower than the rates achieved by others in similar positions (Klieštik et al., 2019). Karels and Prakash in 1987 reported several symptoms that are signs of failure, such as: negative net assets, no payments to creditors, collapse of corporate stock, inability to repay debt, bank overdrafts, non-payment of priority dividends, forced administration, etc. (Sanobar, 2012).

In 1932 FitzPatrick (Klieštik et al., 2019) defined 5 stages in the life of a company that lead to its failure. These are the following stages:

• Stage 1 - Incubation: it is the period during which the unfavourable financial condition of the company develops and deepens.

• Stage 2 - Financial Embarrassment: it is the period in which the first financial difficulties occur.

• Stage 3 - Insolvency: (Financial Insolvency).

• Stage 4 - Total Insolvency: liabilities exceed company's assets.

• Stage 5 - Confirmed Insolvency: the status of insolvent business company is confirmed. At this stage, all legal instruments aimed at protecting creditors' rights are being implemented (Sanobar, 2012).

Bankruptcy is a forced state that follows after the company ran out of money and lost its ability to repay its liabilities or has too many debts. Bankruptcy can be defined as a situation where a company is unable to repay liabilities to its creditors, pay preference shares to shareholders, pay its suppliers or has overdrawn its accounts or the company has gone bankrupt under the relevant law Dimitras et al. (1996). Bankruptcy was also defined by the authors Ding, Song and Zen (2008), who state that bankruptcy is a situation where the company is unable to pay its liabilities, priority dividends and has overdrawn its accounts. In the vast majority of sources dealing with the issue, the authors define bankruptcy as the inability of the company to repay its liabilities, thus triggers bankruptcy processes (Pervan, Pervan and Vukoja, 2011). In 1993 Altman defined the concept of financial distress and pointed out that bankruptcy represents the legal end of financial distress (Ding, Song and Zen, 2008).