Selection of Early Warning Indicator to Identify Distress in The Corporate Sector: Crisis Prevention Strengthening Efforts

Abstract

This study aims to develop an Early Warning Indicator (EWI) that can provideearly signals in the presence of pressure on the financial condition of the corporatesector. Thus, efforts to prevent deeper deterioration can be anticipated earlier inorder to maintain the stability of the financial system. In the first stage, based on thecompany’s financial reports, the probable indicators are grouped into four categoriesi.e. liquidity indicator, solvency indicator, profitability indicator and activity indicator.The indicators, selected as EWI, are the indicators that can predict the occurrence ofcorporate distress events, in the Q1 of 2009, with the minimum statistical error. Theresults of the statistical evaluation showed that in terms of aggregate, the indicators ofDebt to Equity Ratio (DER), Current Ratio (CR), Quick Ratio (QR), Debt to Asset Ratio(DAR), Solvability Ratio (SR) and Debt Service Ratio (DSR) signal within a year beforea distress event occurs in the Q1 of 2009. Thus, these indicators can be considered asEWI in the presence of corporate financial distress.