BPYou don't need me to tell you how the banking crash and recession have pushed many companies to the brink of bankruptcy. Companies such as HMV and the Royal Bank of Scotland (LSE: RBS) have been close to going bust, and with the future in Europe and the banking sector still far from certain, many more companies could be at risk of going the same way.

Investing

Like you, no doubt, I'm always keen to ensure that my potential investments aren't just about to go bust! Indeed, I'm convinced that avoiding losers is just as important as picking winners in today's choppy market.

With all that in mind, I use something called a Z-score to help me sidestep portfolio disasters. The Z-Score was developed in the 1960s and combines various financial ratios, each with a different weighting, to provide an overall verdict on a company's financial health. Effectively, the higher the Z-Score, the less likely the company is to go bust, although this is best taken in context of its industry as a whole. The Z-score is not perfect, of course, and I encourage you to read more information on the subject, perhaps even adapting it to suit your individual needs.

Investing



Today I'm assessing BP. Here are my Z-score calculations:

Ratio
BP

Industry Average

Z-Score

2.57

3.57

Working Capital/Total Assets

3,584/293,068 = 0.02

0.02

Retained Earnings/Total Assets

111,608/293,068 = 0.38

0.62

EBIT/Total Assets

39,817/293,068 = 0.14

0.17

Market Value of Equity/Total Liabilities

87,289.6/180,586 = 0.48

1.26

Turnover/Total Assets

375,517/293.068 = 1.28

1.35

This comparison looked at the full-year results for BP ending December 31, 2011, and compares the figures with the same reports for a number of rival firms, including Royal Dutch Shell and Exxon Mobil.

Overall the financial strength of BP (LSE: BP) was lower than the industry average, mainly due to a lower market value compared to its peers. The measurement used to asses this links actual share prices with a company's financial position, allowing some representation of the market's perceived confidence in the firm. BP's ratio in this area was less than half of the industry average, although it could be the case that this is because the share price was actually undervalued.

BP's Z-Score increased to 2.6 from 1.9 in 2010, while the sector average increased from 3 to 3.6; this represents 37% and 20% increase respectively, showing that overall the strength of BP improved during the period at a greater rate than the industry. Significantly, this came on the back of a large increase in earnings between 2010 and 2011, while the company's nearest rivals saw far smaller increases.

BP's strongest individual ratio was the measurement of profitability given the company's resources; turnover to total assets. This number indicates how well a company can make use of its assets, as well as its ability to mange competition and gain market share. BP's ratio in this area increased by 17% between 2010 and 2011, exactly the same as the sector as a whole, suggesting BP was 'keeping pace' with profitability and expansion.

So there we have it. BP (LSE: BP) would seem to be in a weaker financial position compared to its peer group, although most of this is in the perception of the market and the value of its share price. But to answer the question 'Will BP go Bust?', the answer is: probably not anytime soon.

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