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Best proxy to determine firm performance using financial ratios: A CHAID approach

Author

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  • Yousaf Muhammad

    (Faculty of Management and Economics, Tomas Bata University in Zlin, Mostni 5139, Zlin, 76001, Czech Republic)

  • Dey Sandeep Kumar

    (Faculty of Management and Economics, Tomas Bata University in Zlin, Mostni 5139, Zlin, 76001, Czech Republic, and Czech Mathematical Society, Prague, Czech Republic)

Abstract

The main purpose of this study is to investigate the best predictor of firm performance among different proxies. A sample of 287 Czech firms was taken from automobile, construction, and manufacturing sectors. Panel data of the firms was acquired from the Albertina database for the time period from 2016 to 2020. Three different proxies of firm performance, return of assets (RoA), return of equity (RoE), and return of capital employed (RoCE) were used as dependent variables. Including three proxies of firm’s performance, 16 financial ratios were measured based on the previous literature. A machine learning-based decision tree algorithm, Chi-squared Automatic Interaction Detector (CHAID), was deployed to gauge each proxy’s efficacy and examine the best proxy of the firm performance. A partitioning rule of 70:30 was maintained, which implied that 70% of the dataset was used for training and the remaining 30% for testing. The results revealed that return on assets (RoA) was detected to be a robust proxy to predict financial performance among the targeted indicators. The results and the methodology will be useful for policy-makers, stakeholders, academics and managers to take strategic business decisions and forecast financial performance.

Suggested Citation

  • Yousaf Muhammad & Dey Sandeep Kumar, 2022. "Best proxy to determine firm performance using financial ratios: A CHAID approach," Review of Economic Perspectives, Sciendo, vol. 22(3), pages 219-239, September.
    • Handle: RePEc:vrs:reoecp:v:22:y:2022:i:3:p:219-239:n:3
    DOI: 10.2478/revecp-2022-0010
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    References listed on IDEAS

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    1. G. V. Kass, 1980. "An Exploratory Technique for Investigating Large Quantities of Categorical Data," Journal of the Royal Statistical Society Series C, Royal Statistical Society, vol. 29(2), pages 119-127, June.
    2. Gaurav Jyoti & Ashu Khanna, 2021. "Does sustainability performance impact financial performance? Evidence from Indian service sector firms," Sustainable Development, John Wiley & Sons, Ltd., vol. 29(6), pages 1086-1095, November.
    3. Mohamed Abdel-Basset & Weiping Ding & Rehab Mohamed & Noura Metawa, 2020. "An integrated plithogenic MCDM approach for financial performance evaluation of manufacturing industries," Risk Management, Palgrave Macmillan, vol. 22(3), pages 192-218, September.
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    More about this item

    Keywords

    Czech firms; Decision tree; financial ratios; firm performance; return on assets;
    All these keywords.

    JEL classification:

    • G00 - Financial Economics - - General - - - General
    • L25 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Performance

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