Open Journal of Accounting, 2012, 1, 38-46
http://dx.doi.org/10.4236/ojacct.2012.12005 Published Online October 2012 (http://www.SciRP.org/journal/ojacct)
Going Concern Prediction of Iranian Companies by Using
Fuzzy C-Means
Mahdi Moradi1, Mahdi Salehi2*, Hadi Sadoghi Yazdi3, Mohammad Ebrahim Gorgani4
1Associate Professor of Accounting, Ferdowsi University of Mashhad, Iran
2Assistant Professor of Accounting, Ferdowsi University of Mashhad, Iran
3Associate Professor of Computer Science, Ferdowsi University of Mashhad, Iran
4East Oil and Gas Company, National Iranian Oil Company, Teheran, Iran
Received September 7, 2012; revised October 10, 2012; accepted October 17, 2012
ABSTRACT
Decision-making problems in the area of financial status evaluation have been considered very important. Making in-
correct decisions in firms is very likely to cause financial crises and distress. Predicting going concern of factories and
manufacturing companies is the desire of managers, investors, auditors, financial analysts, governmental officials, em-
ployees. This research introduces a new approach for modeling of company’s behavior based on Fuzzy Clustering
Means (FCM). Fuzzy clustering is one of well-known unsupervised clustering techniques, which allows one piece of
data belongs to two or more clusters. The data used in this research was obtained from Iran Stock Market and Account-
ing Research Database. According to the data between 2000 and 2009, 70 pairs of companies listed in Tehran Stock
Exchange are selected as initial data set. Our experimental results showed that FCM approach obtains good prediction
accuracy in developing a financial distress prediction model. Also, in effective features determination test the results
show that features based on cash flows play more important role in clustering two classes.
Keywords: Going Concern Prediction; Fuzzy C-Means
1. Introduction
The empirical literature of going concern prediction has
recently gained further momentum and attention from
financial institutions. Academicians and practitioners
have realized that the problem of asymmetric information
between banks and firms lies at the heart of important
market failures such as credit rationing and that im-
provement in monitoring techniques represents a valu-
able alternative to any incomplete contractual arrange-
ment aimed at reducing the borrowers’ moral hazard [1].
Traditionally, there are two major research trends in fi-
nancial distress prediction. One is inv estigating the situa-
tion of failure to find the symptoms [2-4]. The other is
comparing the prediction accuracy of the diverse classi-
fication methods [5-6]. This study belongs to the second
type of research. Among financial distress forecasting
methods, discriminant analysis was the dominant method
for predicting corporate failure from 1966 until the early
part of the 1980s [7-9]. It gained wide popularity due to
its ease of use and interpretation. However, both linear
and quadratic discriminant analyses are sensitive to de-
viation from multivariate normality [10] . Duri ng the 1980s,
the method was replaced by the probit [11] and logit
methods (logistic regression model) [12], especially, the
logit model. These two models does give a crisp rela-
tionship between explanatory and response variables of
the given data from a statistical viewpoint and do not
assume multivariate normality, but the probit model as-
sumed that the cumulative probability distribution must
be standardized normal distribution, while the logit model
assumed that the cumulative probab ility d istributio n must
be logistic distribution. Since the 1990s, neural networks
have been the most widely used techniques in developing
quantitative bankruptcy prediction [13], in particular, the
approximation or classification powers of the MLP
trained by the backpropagation algorithm [14]. Many
studies compared the neural networks backpropagation
algorithm with the statistical methods and found neural
networks backpropagation outperforms the other statistic
methods, such as Multivariate Discriminant Analysis
(MDA) [15]. Neural networks have recently been em-
ployed to extract rules for solving fuzzy classification
problems [16]. In particular, the Radial Basis Function
Network (i.e., RBFN), have been widely used in a large
number of fields, such as classification problems [17],
function approximations [18] and management sciences.
*Corresponding a uthor.
C
opyright © 2012 SciRes. OJAcct

M. MORADI ET AL. 39
Actually, the approximation or classification powers of
the MLP trained by the backpropagation algorithm and
RBFN are determined by the number of hidden nodes. In
fact, the performance of backpropagation MLP is further
influenced by the number of hidden layers. Additionally,
an RBFN is functionally equivalent to a zero-order Su-
geno fuzzy inference system under some conditions. In
addition, it was proven that the zero-order Sugeno fuzzy
inference system could approximate any nonlinear func-
tion on a compact set to an arbitrary degree of accuracy
under certain conditions. However, if a phenomenon un-
der consideration does not have stochastic variability b ut
is also uncertain in some sense, it is more natural to seek
a fuzzy functional relationship for the given data, which
may be either fuzzy or crisp. It is proposed the quadratic
interval logit model combining logit and quadratic inter-
val regression models. The result demonstrates that the
quadratic interval logit model is superior to the logit
model. The logit model, the quadratic interval logit mod-
el, the back propagation MLP and the RBFN model all
have their own advantages and limitations [19].
Literature Review
Sun and Li [20] used weighted majority voting co mbina-
tion of multiple classifiers for FDP, and introduced an
integration strategy with subject weight based on neural
network for bankruptcy prediction. They all generated
diverse classifiers by applying different learning algo-
rithms (with heterogeneous model representations) to a
single data set, and concluded that to some degree FDP
based on ombination of multiple classifiers was superior
to single classifiers according to accuracy rate or stability.
The most used machine learning technique is the neural
network model, trained by the back-propagation learning
algorithm (, whose prediction accuracy outperforms sta-
tistical models including Logistic Regression (LR), Lin-
ear Discriminant Analysis (LDA), Multiple Discriminant
Analysis (MDA) and other machine learning models,
such a s k-Neare st N eig hbor (k-NN) and decision trees. In
addition, the Back-Propagation Neural Network (BPN)
model can be used as the benchmark for financial deci-
sion support models. Chen and Du [21] found that pre-
diction performance for the clustering approach is more
aggressively influenced than the BPN model and the
BPN approach obtains better prediction accuracy than the
Data Mining (DM) clustering approach in developing a
financial distress prediction model by applying different
learning algorithms (with heterogeneous model repre-
sentations) to a single data set, and concluded that to
some degree FDP based on combination of multiple clas-
sifiers was superior to single classifiers according to ac-
curacy rate or stability. Tsai and Wu [22] ensemble mul-
tiple classifiers which were diversified by using neural
networks on different data sets for bankruptcy prediction,
and their experimental results showed that multiple neu-
ral network classifiers did not outperform a single best
neural network classifier, based on which they consi-
dered that the proposed multiple classifiers system may
be not suitable for the binary classification problem as
bankruptcy prediction.
The purpose of this paper is to apply Fuzzy Clustering
Means in going concern prediction model. Fuzzy C-
Means (FCM) clustering is one of well-known unsuper-
vised clustering techniques, which allows one piece of
data belongs to two or more clusters.
The paper is organized as follows. In the next section
we review the Fuzzy C-Means (FCM). The proposed
method is explained in Section 3 with some experiments.
In Section 4 we present our findings. Final section in-
cludes the conclusion .
2. Technical Background
Fuzzy C-Means
FCM theory is the perfect one among many fuzzy clus-
tering analysis methods that are effective for pattern re-
cognition; details can be seen in reference. Considering a
sample set X = {x1, x2, ···, xN}, xi Rs, which is requir-
ed to be divided into C categories; the aim of FCM is to
obtain each category’s clustering centre vc by minimizing
the weighed square sum of inner-cluster error.

Therefore, its objective function is as follows
  

2
11
,1
CN m
mcncn
cn
JUVd m 

,


 ， (1)
With constraints
1
1
01, 1, 1
0<< ,1,
1, 1
cn
N
cn
n
C
cn
c
cC nN
s.t.Nc C
nN








 









(2)
where m is the smoothing parameter, which makes it
effective from hard c-means to FCM. This parameter
controls the sharing degree among each fuzzy categories,
bigger m will result in more fuzzy division, or results in
more definitive division. Its experimental range is 1.1 - 5;
μcn is subjection of xn to the cth category; dcn represents
the distance between xn and vc, which often is measured
in Euclidean space. Ji(U, V)—the object ive function
 
2T
cnncnc nc
dxvxvxv 

(3)
U and V can be optimized by performing a number of

M. MORADI ET AL. 40
iterative computations using following Equations (4) to
(6), whose astringency has been pro ve d


21
1
ln
1
/
0,
1,
n
m
C
tn cn
c
n
IΦ
dd
cI
cInΦ









 




(4)
where
 
|1,01,2, ,
ncnnn
I
ccCd ICI  (5)
 
1
1
1xn
Nm
cc
m Nn
cn
n
v 
 


n
(6)
3. Research Method
In this section we explain process of data collection and
features selection, then we review fuzzy clustering algo-
rithm.
3.1. Data Collection and Preprocessing
The database used in this study was obtained Iranian
Stock Exchange. Based on the background of Iranian
listed companies, the criteria whether the listed company
is Specially Treated (ST) by Iranian Stock Exchange is
used to categorize financial state into two classes, i.e.
normal and distressed. The most common reason that
Iran listed companies are specially treated by Iranian
Stock Exchange is that they have had accumulated loss to
Stockholders’ equity more than half (Iran Business law
141 Article). ST companies are considered as companies
in financial distress and those never specially treated are
regarded as healthy ones. This experiment uses financial
data two years before the company is specially treated,
which is often denoted as year (t-2) in many literatures.
The data used in this research obtained from Iran
Stock Market and Accounting Research Database. Ac-
cording to the data between 2000 and 2009, 70 pairs of
companies listed in Tehran Stock Exchange are selected
as initial data set. The preprocessing operation to elimi-
nate missing and outlier data is carried out: 1) Sample
companies in case of missing at least one financial ratio
data were eliminated. 2) Sample companies with finan-
cial ratios deviating from the mean value as much as
three times of standard deviation are excluded. After eli-
minating companies with missing and outlier data, the
final number of sample companies is 120.
3.2. Feature Selection
The current study employs 24 variables. The ratios ini-
tially selected allow for a very comprehensive financial
analysis of the firms including financial strength, liquid-
ity, solvability, productivity of labour and capital, vari-
ous kinds of margins and profitability and returns. Al-
though, in the context of linear models, some of these
variables have small discriminatory capabilities for de-
fault prediction, the non-linear approaches used here can
extract relevant information contained in these ratios to
improve the classification accuracy without compromis-
ing generalization. Feature selection is an important issue
in bankruptcy prediction, as in other problems where a
large set of attributes is available, since elimination of
useless features may enhance the accuracy of detection
while reducing the amount of time for processing the
data. Due to the lack of an analytical model, the relative
importance of the input variables can only be estimated
through empirical methods. A complete analysis would
require examination of all possibilities, for ex ample, tak-
ing two variables at a time to analyze their dependence or
correlation, and then taking three at a time, etc. This,
however, is both infeasible and not error free since the
available data may be of poor quality in sampling the full
input space. 24 financial ratios covering profitability,
activity ability, debt ability and growth ability are se-
lected as initial features (see Table 1).
3.3. Designing Fuzzy Clustering Algorithm
One another data mining techniques is fuzzy clustering. In
fuzzy clustering the fuzzy separation is performed that is
each data with one degree of belong is belonged to each
cluster. In actual circum stances Fuzzy clustering is very
more normal than hard clustering because existing data are
not farced fully to depend to one of the clusters in different
clusters border and they are separated with a belong degree
ranging from 0 to 1, indicating their relation belong.
Fuzzy set theory in clustering analysis is focused on
fuzzy clustering based on fuzzy relations and objective
functions.
With regard to provided explanations the fuzzy clus-
tering algorithm is stated as follow (Table 2).
4. Research Findings
Fuzzy clustering algorithm has been designed so that
in the first stage the data are divided to two distinctive
clusters. For this purpose, this technique will determine
effective features that cause to the best clustering. De-
termining effective features is performed by using acci-
dently selection method which it test different fea-
tures1000 times to achieve to the best clustering. This
algorithm is started with determining an effective feature.
On the other hand, this features result in the best cluster-
ng and this trend. i

M. MORADI ET AL. 41
Table 1. Definition of predictor variables.
Variable Financial Ratios Description VariableFinancial Ratios Description
X1 Funds provided by operations to
stockholders’ equity X13 Accumulated earnings to total assets
X2 Funds provided by operations to total liabilities X14 Current ratio
X3 Net working capital to total assets X15 Interest expenses to total expenses
X4 Total assets turnover X16 Debt ratio
X5 Monetary asset to current assets X17 Inv entory stock turnover
X6 Monetary asset to current liabilities X18 Gross income to sales
X7 Earnings before interest and taxes to
interest expenses X19 Net income to Stockholders’ equity
X8 Net interest expenses to total liabilities X20 Net income to sales
X9 Funds provided by operations
to net working capital X21 Net working capital to sales
X10 Earnings before interest and taxes to total assets X22 Intere st ex pens es to sales
X11 Natural logarithm total assets X23 Interest expenses to net working capital
X12 Inventory stock to curren t assets X24 Market value stockholders’ equity to total assets
Table 2. Fuzzy clustering algorithm.
a) Initial amount is consist of determining the number of clusters, amount of repeat parameter, error maximum, belong functions for one
data on all clusters.
b) k = 1 is clustered by one feature. Fe atures 1 to 24 are aligned randomly.
c) Centers of clusters and covariance matrix are determined by using relevant equivalents.
d) Amounts of data belong degree to clusters are determines according to related equivalents.
e) The repeat from b) to d) as many as 1000 times to reach the objective function to the best local minimum then algorithm is stopped.
f) Selecting effective better k based on the best result of pre-stated crit eria.
g) Increasing k and repeating from second step until k = 24 is obtained.
Summary of research results based on selection feature
have been provided in the following Table 4:
Will continue until to select all of the features for
clustering; summary of results from testing algorithm
based on fuzzy clustering by using data in the year of
occurring financial distress(t year) have been provided in
the following exh ibit (Table 3).
where:
α1: Number of accurately categorized total going con-
cern data/on number of total going concern data.
α2: Number of total accurately categorized financial
insolvent data/number of total fin anc ial insolvent data
The nearer the being different of two clusters is the
better the clustering it is and there is maximum non-
conformity between two clusters. As it is seen between
selecting 3 features to 12 features it have been obtained
identical percents. That is, in this algorithm selection of
two and twelve features for clustering have similar re-
sults and there is not any difference between degrees of
non-conformity between two clusters.
β1: Number of incorrect data in the first group/number
of total incorrect da ta and
β2: Number of incorrect data in the second group/
number of total incorrect data.
As it is observed the feature 7 (Earnings before interest
and taxes to sales) have played an important role in ca-
tegorizing data and it result in better clustering. With
feature 7 the two fuzzy clusters is generated, 93.33 per-
cent (α1) have conformity with going concern group and
100 percen t (α2) have conformity with financial inso lvent
and all errors (β1) is related to going concern cluster.
Now, another test is performed to determine degree of
conformity for each data (firms) by Iran Business Law
Article 141. In this stage, the percent of conformity for
two generated clusters by fuzzy clustering with two clus-
ters that have been categorized to going concern firms
and insolvent groups according to article 141 is tested. It
could be determined their belong percent to each groups. As it is observed the percent of going concern classi- fication have not been improved as the features increase

M. MORADI ET AL. 42
Table 3. Determining effective features by using fuzzy clustering in the year of financial distress.
Number of item Effective features Degree of non-conformity
1 7 0.9643
12 17, 2, 12, 11, 15, 10, 9, 4, 20, 23, 7, 8 1.000
18 20, 22, 23, 1, 4, 14, 2, 15, 17, 9, 8, 7, 5, 6, 3, 18, 12, 21 0.9298
24 All 0.8966
Table 4. Conformity between fuzzy clusters and clusters of Business Law Article 141 in financial distress year.
6 α1 α2 β1 β2
7 0.9333 1 1 0
17, 2, 12, 11, 15, 10, 9, 4, 20, 23, 7, 8 0.9167 1 1 0
20, 22, 23, 1, 4, 14, 2, 15, 17, 9, 8, 7, 5, 6, 3, 18, 12, 21 0.95 1 1 0
All 0.9667 1 1 0
until number of selection features would arrive to 18
features for clustering which it indicate 95% of data have
classified correctly. Hereafter as the number of features
increase, the percent of classification is improved until
the clustering with all features result in going concern
data classification with 96.67%. Clustering by this data
based on belong percent of each data result in a classifi-
cation type which generate higher conformity by using
Article 141. Belong percent of data indicate amount of
data dependence in the group.
Results from algorithm test based on fuzzy clustering
by using data in the year before financial distress (t-1
year) have provided in the fo llowing Table 5.
Another test was performed to determine the confor-
mity for each data (firms) by Business law Article 141.
In this test the firms are classified to going concern and
insolvent groups. It could be determine their belong per-
cent to each of groups. Summary of research results
based on selection feature have provided in the following
Table 6.
As it is observed the feature 9 (operating cash to
working capital) have played a more important role in
data classification and it resulted in better clustering. So
that as features increase the percent of classification have
not improved but gradually as features increase the clus-
tering have improved until clustering with 15 features
result in to classify going concern da ta with 98.8%.
Results from algorithm lest based on fuzzy clustering
by using data in two years before financial distress (t-2
year) have bee n pr o vi de d in Table 7.
Now we perform another test to determine amount of
conformity between data (firms) by Business Law Article
141. In this test, firms are classified to going concern and
insolvent group. It could be determine their belong per-
cent to each of the group. Summary of research results
based on selection featu re ha v e provided in Table 8.
As it is observed feature 2 (operating cash to total li-
abilities) is the first important feature for classifying data
and it result in better clustering. Results of research indi-
cated that as feature increase the percent of classification
is improved until (as long as) clustering with 15 features
result in the best classification for going concern data
with 96.67%. However, here after as the features increase
and including inefficient features to the model result of
clustering is reduced.
Generally results of algorithm test based on fuzzy clus-
tering indicated that the model in classifying going con-
cern data using data in the year of financial distress, one
year and two years before financial distress 96.67%,
83.44% and 77.34% of going concern firms classify cor-
rectly respectively and in classifying financial insolvent
data this model classify data in the year of financial dis-
tress, one and two years before it 100%, 100% and
98.32% respectively.
Also, in effective features determination test the re-
sults show that in the year of financial distress the fea-
tures based on leverage ratios (Earnings before interest
and tax deduction to interest cost) result in to separate
two classes better than before and the more far from in-
cident year we are the more important role the features
bases on cash flows (operating net cash flows to working
capital or total debt) in clustering tow classes will play.
Geometrical Describe of Belong Percent for Each
Firms to Going Concern and Insolvent Classes
As it was stated the fuzzy clustering method is able to
determine even belong percent of each one of data to
every class so that it is observed this method convey data
(x) is belong to going concer n class with 80% and belon g

M. MORADI ET AL. 43
Table 5. Determining effective features by fuzzy clustering in the year before financial distress.
Number of item Effective features Degree of non-conformit y
1 9 0.9231
4 3, 9, 15, 23 0.9608
15 9, 15, 3, 23, 18, 6, 13, 4, 5, 12, 14, 19, 2, 8, 11 0.8519
24 All 0.8519
Table 6. Conformity for fuzzy clusters with clusters generated based on business law article 141 in the year before financial
distress.
Effective features α1 α2 β1 β2
9 0.94 1 1 0
3, 9, 15, 23 0.9273 1 1 0
9, 15, 3, 23, 18, 6, 13, 4, 5, 12, 14, 19, 2, 8, 11 0.9818 1 1 0
All 0.8344 1 1 0
Table 7. Determining effective features by using Fuzzy clustering in two years befor e financial distr ess.
Number of item Effective features degree of non-conformity
1 2 0.9667
4 2, 12, 14, 8 0.9677
15 19, 22, 14, 4, 1, 2, 3, 12, 5, 6, 10, 8, 18, 15, 20 0.8769
24 All 0.7538
Table 8. The results of the study.
Effective features α1 α2 β1 β2
2 0.8387 0.8667 0.55 0.45
2, 12, 14, 8 0.9355 0.95 0.5714 0.4286
19, 22, 14, 4, 1, 2, 3, 12, 5, 6, 10, 8, 18, 15, 20 0.9677 0.90 0.25 0.75
All 0.7734 0.9832 0.96 0.04
to insolvent class with 20% and in some data it is ob-
served that data (z) belong to going concern class with
56% and to insolvent with 44%. Especially this problem
matter in the data basses which data of two classes are
selected based on pair sampling. To better understand of
this problem the belong percents of data is indicated
geometrically on the following graphs in the financial
distress occurrence year. Horizontal axis show the num-
ber of firms and vertical axis show the per cent of belong
for data to its class. Financial distress data are in the right
side and going concern data are in the left side in this
axis. The closer the data in its class to top horizontal ax is
or down are, their percent belong to its class is greater.
As it is observed in the above Graphs 1-4 as features
increase in the year of financial distress the two classes
have separated significantly and with high belong percent
are belong (dependent) to their class.
Belong percent of data in year before financial distress
in the following Graphs 5-8 states that as features in-
crease the separation is performed more desirably and
data show more belong to their class.
Belong percent of data in two years before financial
distress in the following Graphs 9-12 is indicated.
Belong percent of data in two years before financial
distress in the above graphs states that as features in-
crease the separation is performed more desirably and
data show more belong to their class. But should be no-
ticed that the more far from the year of financial distress
we are the harder the separation of two classes it is and use
of more variables result on variables interference so that it

M. MORADI ET AL. 44
Graph 1. Belong percent of data with one feature.
Graph 2. Belong percent of data with twelve features.
Graph 3. Belong percent of data with eighteen features.
Graph 4. Belong percent of data with all features.
Graph 5. Belong percent of data with one feature.
Graph 6. Belong percent of data with four fe atures.
Graph 7. Belong percent of data with fifteen features.
Graph 8. Belong percent of data with all features.

M. MORADI ET AL. 45
Graph 9. Belong percent of data with one feature.
Graph 10. Belong percent of data with four features.
Graph 11. Belong percent of data with fifteen features.
Graph 12. Belong percent of data with all features.
is observed the use of all variables in two years before
financial distress have resulted in data would belong to a
class with lower belong percent. On the other hand, it
could be concluded that the more far from the year of
financial distress we are some features have not neces-
sary efficiency for classification and use of all variables
would not be correct in the model.
5. Conclusion
Results of algorithm test based on fuzzy clustering indi-
cate that the model would cluster going concern data by
using data in the year of financial distress, one two years
be for financial distress with 96.67%, 85.19% and
77.74% respectively for going concern firms. Also, in
effective features determination test the results show that
in the year of financial distress incident the features
based on profitability (earnings before interest and tax
deduction to interest cost) would resu lt in to separate tow
classes more desirably and the more far from year of
financial distress we are, the features based on cash flows
(operating net cash flow to wo rking capital or total debt)
play more important role in clustering tow classes.
6. Suggestions for Future Researches
To guide students and researches interested to research in
the area of subject of present thesis the following sugges-
tions is provided:
1) Sort the data based on their belong percent in fuzzy
clustering to three or four classes.
2) Use different fuzzy clustering method and deter-
mine belong percent of samples based on different tech-
niques to going concern and insolvent classes.
3) Compare this method with other techniques such as
neural networks method or nearest.
4) Use combination of other variables (different an-
other classes of financial ratios) for designing the model.
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