THE ROLE OF FINANCIAL RATIOS IN PREDICTING FINANCIAL DISTRESS TWO YEARS BEFORE ITS OCCURRENCE IN FINANCIAL SERVICES COMPANIES LISTED ON THE AMMAN STOCK EXCHANGE (A PROPOSED MODEL)

Abstract

This research aims to identify the optimal set of financial ratios that can be used to predict financial distress for financial services companies listed on the Amman Stock Exchange. The early identification of potential financial distress allows relevant stakeholders and regulatory bodies to intervene with appropriate corrective measures in a timely manner. The statistical technique of multivariate linear discriminant analysis was employed to determine the best set of financial indicators for building the prediction model. This model enables differentiation between distressed and healthy companies two years before the occurrence of distress. Financial ratios were calculated for a sample of 18 companies, half of which were distressed and the other half non-distressed, covering the period from 2014 to 2021. The resulting model is as follows:

Z = -0.61X_1 + 2.96X_2 - 245.17X_3 + 1.33X_4 + 18.75X_5 - 49.83

The model, upon testing, demonstrated its ability to distinguish between distressed and non-distressed companies with a prediction accuracy of 72%.