The H-Score provides an immediate and reliable evaluation of any company’s fundamental financial health. It is derived from a company’s published financial results and quantifies how closely the accounts resemble those of companies which subsequently failed.
This is a sophisticated mathematical process, known as Discriminant Analysis, by which patterns in the characteristics of companies are identified and used to optimally discriminate between membership of two pre-constructed alternative groups: in this case, companies which subsequently failed and companies which did not fail (within a specific time frame). Using the results of this analysis, a live company can be evaluated on the same criteria. If it resembles the companies which subsequently failed, it is displaying similar weaknesses and is itself at risk of failing. The greater the resemblance to failed companies the weaker the company and greater the risk of it failing itself. If it bears no resemblance to the companies which subsequently failed, it is in no immediate risk of financial distress. This evaluation process forms the basis of a suite of specific H-Score models each tailored to an economic or cultural region of the world, and each continually maintained and recalibrated over time.
The H-Score is a ranked percentile score and takes a value from 0 to 100. This means, for example, that if a company’s H-Score is 15, then only about 15% of the population have characteristics even more indicative of failed companies, and to that extent the company’s health is judged to be relatively weak. It is possible to identify an ideal threshold in the H-Score scale, above which companies have little similarity to failed companies and a marginal likelihood of financial distress, but below which the vast majority of actual failures fall using information available prior to failure. If, for example, this threshhold is set at 25, then companies with an H-Score of 0 to 25 can be described as being in the Warning Area.
Crucially, the analysis is not saying that every company with an H-Score of 0 to 25 will fail, but that the H-Score of the vast maority of failed companies were in this range prior to their failure. The ability to set such a threshold, below which a user can concentrate risk management resources,exploits a valuable sifting property unique to discriminant scales.
The H-Score was developed by Company Watch
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