Altman Z-Score
Altman Z-Score is a numerical measurement used to predict the chances of a business going bankrupt in the next two years. As one of the most popular bankruptcy prediction models, the Altman Z-Score is considered an effective method of predicting the state of financial distress of any organization by using multiple balance sheet values and corporate income. The formula is made up of liquidity, solvency, profitability, leverage, and activity ratios. Each ratio is given a weighting, culminating in the calculation of the Z-Score. The model was developed by American finance professor Edward Altman in 1968 as a measure of the financial stability of companies.
MORE ABOUT THE ALTMAN Z-SCORE
The Altman Z-Score is the gold standard for measuring a company's risk of insolvency and predicting whether a company will declare bankruptcy.
A score below 1.8 means it's likely the company is headed for bankruptcy, while companies with scores above 3 are not likely to go bankrupt.
Investors use the model to make a decision on whether to buy or sell a company’s stock, depending on the assessed financial strength.
Z-SCORE FORMULA
Z = 1.2A + 1.4B + 3.3C + 0.6D + 0.99E
The letters in the formula designate the following measures:
A = Working capital / Total assets [ Measures the relative amount of liquid assets]
B = Retained earnings / Total assets [Determines cumulative profitability]
C = Earnings before interest and taxes / Total assets [measures earnings away from the effects of taxes and leverage]
D = Market value of equity / Book value of total liabilities [incorporates the effects of a decline in market value of a company's shares]
E = Sales / Total assets [measures asset turnover]