The economic crisis was beginning to affect economies in Malaysia in July 1997, these were caused many companies fall into financial distress and facing the threat of unable to pay debt and difficult to fulfill corporate obligations due to there was unable to cope with the economic downturn (Low et al., 2001). The Impact of the crisis on corporate failure in Malaysia was seen through indicators such as company liquidation, default in debt repayment, and noncompliance with reporting as well as rating action (Khong et al., 2011).
The prediction and prevention of financial distress are one of the major factors that should be analyzed in advance as an early warning signal and to avoid the high cost of bankruptcy. Bankruptcy involves costs for both the shareholders and stakeholders.
According to Sun & Lin (2007), with the gradual perfection of stock market mechanisms and bankruptcy laws, financial distress not only makes the company suffer great economic loss but also directly affect its survival and growth. Therefore, an effective way to predict financial distress is crucial in assisting and facilitating the management of the company to act immediately before the financial problem and getting worse and it is too late to take remedial action. Although that were many attempts to promote various methodological approaches to predict financial distress, the usefulness of financial ratio has been acknowledged by many.As mentioned by Ugurlu and Aksoy (2006), the early researches we focused on the comparison of value ratios on failed and non- failed firms.
According to Elloumi and Gueyie (2001), when a firm’s business deteriorates to the point where it cannot meet its financial obligations, the firm is said to have entered the state of financial distress.The first signals of distress are usually violations of debt covenants coupled with the omission or reduction of dividends.Entry into financial distress can be defined as the first year in which cash flows are less than the current maturities’ long-term debt. As long as cash flow exceeds current debt obligations, the firm has enough funds to pay its creditors. The key factor in identifying firms in financial distress is their inability to meet contractual debt obligations.
There are several indicators and information sources that can help in the prediction and prevention of financial distress. These are cash flow analysis of the current and future periods, corporate strategy analysis, which analyses the potential competitors of the firm or institution, its relative structure, plant expansions in the industry, the ability of firms to pass along cost increases, and the quality of management. Another information source comes from external variables such as security returns and bond ratings. Financial statement analysis is one of these methods that can be used in predicting financial distress, which focuses on financial variables.
Lastly, the financial ratio analysis can be applied in identifying problems of financial distress for every consumer product companies listed on Bursa Malaysia.Based on previous studies of four consumer product companies listed on Bursa Malaysia were identified financial distress.Hasabullah et al., (2009) has provided an insight into the financial analysis of data by using a ratio analysis, which can be used as an early alerting method for financial failure among companies listed in the stock exchange.Financial analysis is a tool that helps management to make decisions and plans and control them.