Evaluation of Bankruptcy Risk Faced by Thomas Cook Ltd

ACFI3310 INDIVIDUAL COURSEWORK ASSIGNMENT
PXXXXXXX

DATE: 30TH SEPTEMBER 2018
MEMORANDUM
TO: POTENTIAL SHAREHOLDER
FROM: FINANCIAL ADVISOR
SUBJECT: EVALUATION OF THE BANKRUPTCY RISK FACED BY THOMAS COOK LTD
In response to your query, I have reviewed Thomas Cook as a potential investment and so the purpose of
this memo is to assess the likelihood of Thomas Cook going bankrupt, with the help of several bankruptcy
models; Beaver, Altman and Argenti.
1. Beaver Overview (1966)
Most researchers investigating bankruptcy have utilized Beaver’s model to predict the likelihood of
bankruptcy using the six best predictive ratios outlined in Appendix 1.1. Beaver (1966, p79) emphasized the
strength of a uni-variate analysis reflects the selection of few ratios, the “six common element groups”.
However, there are certain drawbacks related to selecting an optimum cut-off point. Appendix 1.1 highlights
the significant drop in cash flow between 2017 (£345m) and 2018 (£23,000) indicative of how much Thomas
Cook might struggle to reduce debt as opposed to seeking out new capital investment appraisals. See
Appendix 1.1 for a complete Beaver analysis.
2. Altman Overview
Shaked and Dionne (2018, p52) illustrate Beaver as the original model used to predict bankruptcy using
financial ratios and other statistical techniques to form the multivariate discriminant model. Previous
research has established that a Z score fewer than or equal to 1.8 suggests a high probability of bankruptcy
and scores between 1.8 and 3 indicate safety. It is important to stress the figures used only represents one
day in the financial year. In 2018, Thomas Cook scored 0.902 which signifies a high probability of
bankruptcy. Similarly, in 2018 X1 offers key insight into Thomas Cook’s negative working capital and how
this could later affect the company’s ability to carry on as going concern. Throughout the years, Thomas
Cook has displayed negative balances for working capital and this is reflected in its low Z score (Appendix
1.2)
3. Argenti

Argenti and Goodrick-Clarke (1976) stipulated that failure to comply with any one of the six defects may
“lead a company to disaster”. The total mark for defects is 45 and Argenti suggests that a mark of 10 or less
is satisfactory. Results shows that Thomas Cook scored 25 which implies that a multitude of issues and the
most glaring finding to emerge from the analysis is Chief Executive (Appendix 1.3). Regarding mistakes, the
Group’s decision to overtrade may have caused significant delays in creditor days among other impacts
(See Appendix 1.3). Interestingly, Thomas Cook did not pass any of the Argenti sections which is quite
worrying and the Argenti score of 75 far exceeds the pass mark of 25. Perhaps the failure in planning and
passive board engagement could explain this outcome (ACCA, n.d.). See Appendix 1.3.
Collectively, this study captured key financial and non-financial results that could cause bankruptcy, such as
“poor business planning, poor financial planning, poor marketing and poor management” (ACCA, nd).
Beaver valuable contribution highlighted the significance of financial ratios helping to predict bankruptcy.
Similarly, the Altman approach took inspiration from Beaver and attempted to analyse multiple financial
ratios to determine a figure that would prove the likelihood of a company failure. Argenti’s method improved
upon the relevancy of certain non-financial ratios as better warning signs to bankruptcy e.g. autocratic chief
executive. Considering all of this evidence, it seems that Thomas Cook will likely go into bankruptcy and I
would advise against investing your money into this company.
Please do not hesitate to respond back to this memo if you have further queries.
Thanks for your anticipated response.
Your Financial Advisor

Appendix
1.1 Beaver Model: Thomas Cook and British Airways (30th December 2018)