Introduction
Managerial accounting is concerned with supporting managers’ decision-making using financial data. It can help managers to understand current performance, anticipate and plan for financial risks, and achieve organizational goals. Bankruptcy is a particularly important concept in this area of accounting since predicting bankruptcy in advance can aid companies in avoiding it or planning for losses. Generally, auditor reports are used to forecast and understand the risk of bankruptcy. However, Altman’s Z-Score analysis can also be helpful in fulfilling this goal. The present paper will focus on the bankruptcy of Blockbuster, a video rental giant that went bankrupt in 2010. The report will provide an overview of the company and perform Altman’s Z-Score analysis to explore whether this technique would have been more reliable than auditor reports in predicting the bankruptcy of Blockbuster.
Company Overview
Blockbuster was an American company operating in the entertainment industry. The company provided film and video game rental services to customers through a variety of channels. For example, customers could rent DVDs from Blockbuster rental shops, as well as via mail and streaming services. The company was founded in Texas in 1985 and expanded to other regions before the early 2000s. However, in 2010, the company filed for bankruptcy as its success declined due to rigorous competition and the emergence of alternative providers. The present section will contain information on the company’s background, competition, and bankruptcy, as well as present the results of Altman’s Z-Score Analysis.
Background
The history of Blockbuster can be traced back to a software services company in Texas. David Cook was the owner of Cook Data Services, a company offering software solutions to oil companies all around Texas (Poggi, 2010). The collapsing oil market prompted him to enter a different industry, and the first Blockbuster store opened in Dallas, Texas, in 1985 (Poggi, 2010). At the time, the demand for films on VHS tapes was high, which enabled the company to occupy a strong position in the entertainment industry quickly. Besides film rental, Blockbuster also offered video game rental services, which partly accounted for the company’s increasing popularity.
One of the most significant turns of events for Blockbuster occurred in 1986-1987. At first, Cook planned for Blockbuster to go public, but his attempt was unsuccessful due to a news article reporting his lack of experience in the entertainment industry (Poggi, 2010). Consequently, the public offering was canceled, which threatened the company’s future. In search of investments to support future growth, Cook sold one-third of Blockbuster’s shares to investors, including the founder of Waste Management Wayne Huizenga. Soon, Huizenga obtained control of the company and redefined its business model to switch from franchise-based growth to battling competitors (Poggi, 2010). The chain of poor decisions, as well as the increased pressure from emerging competitors, caused Blockbuster to file for bankruptcy in 2010.
Competition
At first, Blockbuster’s primary goal was to distinguish itself from the competition. While video rental services were not new to Texas, Blockbuster capitalized on the range of titles available. As explained by Poggi (2010), “with more than 8,000 VHS tapes in more than 6,500 titles, Cook’s Blockbuster store was three times larger than its nearest competitor” (para. 6). The popularity of Blockbuster stores grew rapidly because customers could always find what they needed there. Additionally, Blockbuster stores were usually open late, had an easier checkout process, and displayed titles on shelves instead of over the counter (Poggi, 2010). This contributed to the customers’ in-store experience and enabled Blockbuster to earn more profits by differentiating its services from competitors’.
However, the approach to overcoming competition changed with the arrival of Wayne Huizenga. His primary goal was to rid Blockbuster of competition in the entertainment sector through acquisitions. A sequence of acquisitions was carried out in the late 80s (Poggi, 2010). Blockbuster was able to acquire some of its key rivals, including Major Video and Erol’s. The company also began its expansion into other areas of the entertainment industry by acquiring music retail companies, namely the Sound Warehouse and Music Plus (Poggi, 2010). While the acquisitions enabled Blockbuster to improve its competitive position and grow into a multibillion-dollar business, they also affected the company’s flexibility due to the large number of stores operated.
The emergence of new technologies threatened Blockbuster’s competitive position and sales. In the 1990s, pay-per-view and cable programming were growing in popularity, affecting the demand for video rental, which remained Blockbuster’s main line of operations (Poggi, 2010). Consequently, the company’s sales growth was hindered, and analysts reported concerns regarding its long-term performance. After Viacom purchased Blockbuster for $8.4 billion in 1993, the company’s internal operations suffered from changes in management. For example, as mentioned by Poggi (2010), Blockbuster stores were slow on acquiring new releases, and store operations became less efficient because of staff shortages. This affected the popularity of Blockbuster’s services and reduced its financial performance even further.
The development of web technologies also hit Blockbuster by enabling Amazon and Netflix to enter the entertainment industry. Blockbuster attempted to capitalize on the new technology by partnering with AOL to start streaming services, but its progress was too slow; online DVD rental matching Netflix’s features did not appear until 2004 (Poggi, 2010). The failure to respond to critical industry changes was mainly due to the fact that the management’s attention was diverted to acquisitions and store operations. As a result, the company’s sales plummeted, and debts grew, leading to bankruptcy.
Bankruptcy
Based on Blockbuster’s financial report for 2005, there were some signs that the company was experiencing financial difficulties that could result in bankruptcy. Namely, the company’s financials reflect operating losses instead of income, with the 2005 losses constituting $426.5 million (Blockbuster Inc., 2005). The net losses reached $588.1 million in 2005 (Blockbuster Inc., 2005). The company’s total assets also posed a concern, reducing from $7,771 million in 2001 to $3,179.6 million in 2005 (Blockbuster, Inc.). Stakeholder’s equity decreased drastically in the same period, from $5,676.1 million to $631.6 million. Although these signs suggested possible bankruptcy in the future, it was still possible for the management to remain hopeful about Blockbuster’s performance. For example, total losses and operating losses showed a significant improvement compared to the previous year. Additionally, the revenues and gross profits remained relatively stable between 2001 and 2005. These improvements could have misled the management into thinking that the situation was improving five years before Blockbuster was forced to file for bankruptcy.
The reasons for Blockbuster’s declining financial performance and eventual bankruptcy were the same. On the one hand, the company’s acquisition strategy created a burden in the form of thousands of stores that brought significant losses once video rental became less prevalent in the 2000s (Tyler, 2017). On the other hand, the focus on acquisitions and operations management that was required to implement the selected strategy rendered Blockbuster blind to developments in the industry. By the time the company realized what the preferred course of action was, it was already years behind its new competitors (Tyler, 2017). The increasing pressure from emerging competitors, including Netflix, as well as financial difficulties incurred as a result of operating losses, became the ultimate cause of Blockbuster’s bankruptcy in 2010.
Altman’s Z-Score Analysis
Altman’s Z-Score is a measurement reflecting the company’s current status and financial stability. It is based on several prominent financial figures, including assets, liabilities, retained earnings, net income, market value, shares, and sales. The formula for Altman’s Z-Score is as follows: Z=1.2X1+1.4X2+3.3X3+0.6X4+1.0X5. The formulas and values for X1 to X5, as well as Altman’s Z-Score calculations, are presented in Table 1. Based on the figures from the company’s 2005 financial report, Blockbuster’s Z-Score was approximately -1 at the time. According to the classification of Z-Score values, results less than or equal to 1.81 reflect the company’s financial failure and can be used to predict bankruptcy. Since Blockbuster’s outcome is far less than this figure, applying Altman’s Z-Score analysis to its financial data for 2005 would have indicated the forthcoming bankruptcy.
Table 1. Altman’s Z-Score Values and Calculations
X
Formula
Blockbuster’s 2005 Values
(all in millions)
Result
X1
(Current Assets- Current Liabilities)/ Total Assets
(1,423.8-1,317.9)/ 3,179.6
0.03330607623
X2
Retained Earnings/ Total Assets
-4,836.4/3,179.6
-1.52107183293
X3
Net Income Before Interests and Tax/ Total Liabilities
-588.1/2,785.1
-0.21115938386
X4
(Market Value per Share*Number of Shares)/ Total Liabilities
(-1.4*191.454598)/2,785.1
-0.09623943025
X5
Sales/ Total Assets
5,864.4/3,179.6
1.84438294125
Altman’s Z-Score calculation
Z=1.2*0.03330607623+1.4*-1.52107183293
+ 3.3*-0.21115938386+0.6*-0.09623943025+ 1.0*1.84438294125
Z= 0.03996729147-2.1295005661-0.69682596673-0.05774365815+1.84438294125=-0.99971995826
Z=-1 (rounded)
Comparison of Altman’s Z-Score and the Auditor’s Report
In order to provide recommendations for future use, it is essential to explore the application of Altman’s Z-Score analysis and the auditor’s report in predicting performance and estimating the risk of bankruptcy. As evident from the analysis above, applying Altman’s Z-Score to a company’s financial data for a given year can help to evaluate whether it is at risk of going bankrupt. This technique takes into account the key indicators of financial performance, which makes the results reliable. In contrast with financial performance ratios, Altman’s Z-Score also includes calculations related to share value and market value, which are crucial for estimating financial reliability. Therefore, the score provides an adequate and focused interpretation of financial data.
However, it is also critical to note that Altman’s Z-Score analysis has some limitations. For example, it only takes into account the data for one fiscal year. If a company experiences a decrease in assets or share value because of temporary circumstances, the results provided by Altman’s Z-Score may not be entirely accurate. The score also does not reflect market opportunities that a company could seize to become more profitable. For instance, if a company is in the process of developing a new product portfolio or plans to enter a new market, it could still succeed regardless of the results of Altman’s Z-Score analysis.
The value of the auditor’s report is that the auditor can take into account the overall conditions in which a business operates and make predictions based on both financial and market data. The auditor’s report also provides information regarding the company’s accounting practices, which shows whether or not the figures presented for review reflect the situation accurately. The possible downfall of the auditor’s report in predicting bankruptcy is that the auditor might fail to include all relevant financial data in their analysis. Significant gaps, in turn, can affect the reliability of predictions. Hence, both techniques have strengths and weaknesses that affect their application in real-life situations.
Conclusions and Recommendations
On the whole, analyzing Blockbuster’s bankruptcy offers some critical insights for managerial accountants. First of all, it highlights the vital influence of strategy on the risk of bankruptcy. While the competitive strategy implemented by Huizenga improved Blockbuster’s financial performance in the short term, it paved the company’s path to bankruptcy. Therefore, understanding the long-term impact of strategic choices can help to highlight future financial risks. Secondly, it shows the need to consider all relevant financial data while analyzing and forecasting performance. While some economic indicators provided in Blockbuster’s 2005 financial report seemed to be improving, a more detailed analysis confirmed that the company’s situation was dangerous.
In order to fulfill the goals of managerial accounting, it is essential to apply reliable analytic tools to analyze financial performance. Both Altman’s Z-Score analysis and the auditor’s report provide information that can help to predict the potential bankruptcy. The first technique is particularly useful because it allows for an objective evaluation of the company’s current status. Still, the auditor’s report is valuable because it offers a broader perspective on performance and determines the reliability of the company’s reporting practices. Based on these considerations, Altman’s Z-Score analysis should be used as the primary tool for evaluating financial performance and the risk of bankruptcy. However, if a company is in the midst of making changes to products or operations, as well as in unstable market conditions, it should be supported by the auditor’s report. Applying these recommendations in practice would help to make reliable predictions that are relevant to the company’s current situation.
References
Blockbuster, Inc. (2005). Form 10-K.
Poggi, J. (2010). Blockbuster’s rise and fall: The long, rewinding road. The Street. Web.
Tyler, A. (2017). Blockbuster: It’s failure and lessons to digital transformers.