Applying Z-score model to distinguish insolvent construction companies in China

Fierce competition in the construction industry in China in recent years has brought many challenges to construction contractors. It is important that any potential company insolvency be recognized at the earliest opportunity. Using financial ratios and the Altman Z-score modelling methodology, an insolvency warning model is developed in order to evaluate the performance of construction contractors in China. The model derived from this study has consistent predictability based on a three-year window of data. It combines seven financial ratios, covering a company’s finance of operation, profitability, solvency and cash flow. A single performance index is derived to differentiate whether a company has good financial standing or exhibits characteristics of insolvent companies. A mechanism to detect insolvent contractors is proposed for sustaining corporate development in construction. It is recommended for a contractor to develop a complete precaution system of financial crisis and have a regular checking of the key financial ratios as well as operation status so as to avoid insolvency.

► Financial ratios and the Altman Z-score modelling methodology are used to evaluate the performance of construction contractors in China.
► The model combines seven financial ratios, covering a company's profitability, solvency and cash flow.
► A two-step procedure is used for model development whereby contractors are first classified into solvent and potentially insolvent groups through cluster analysis while the best discriminating variables are determined by multivariate discriminant analysis.
► The Z-score model developed has consistent predictability based on a three-year window of data.