The Altman Z-Score is a financial metric used to predict the likelihood of a business going bankrupt within the next two years. Developed by Edward Altman in 1968, it combines various financial ratios into a single score to assess a company’s financial health.
Formula for Altman Z-Score
The formula varies for different types of companies (public, private, manufacturing, or non-manufacturing). For publicly traded manufacturing firms, it is:
Z=1.2X1+1.4X2+3.3X3+0.6X4+1.0X5
Where:
- X1: Working Capital / Total Assets
- X2: Retained Earnings / Total Assets
- X3: EBIT / Total Assets
- X4: Market Value of Equity / Total Liabilities
- X5: Sales / Total Assets
Interpreting the Score
- Z > 2.99: Low risk of bankruptcy (safe zone)
- 1.81 < Z < 2.99: Moderate risk (gray zone)
- Z < 1.81: High risk of bankruptcy (distress zone)
Uses in Business
- Risk Assessment: Investors and creditors use the Z-score to evaluate the financial stability of companies and assess credit risk.
- Decision-Making: Businesses use it for self-assessment, identifying financial weaknesses to improve operational efficiency and solvency.
- Comparative Analysis: The score helps compare financial health across firms, industries, or over time.
- Mergers & Acquisitions: Acquirers use the Z-score to assess the viability of target companies.
Limitations
- It is less accurate for non-manufacturing or newer businesses.
- Market value dependence can make it volatile in fluctuating markets.
Despite these limitations, the Altman Z-score remains a powerful tool for proactive financial management and decision-making. It can be one of the tools in your “tool set” to analyze customers’ credit worthiness, target businesses to acquire, or understand your own company’s financial stability.
Understanding the Altman Z-Score for Business The Altman Z-Score is a financial metric used to predict the
likelihood of a business going bankrupt within the next two years. Developed by
Edward Altman in 1968, it combines various financial ratios into a single score
to assess a company’s financial health.
Formula for Altman Z-Score The formula varies for different types of companies (public,
private, manufacturing, or non-manufacturing). For publicly traded
manufacturing firms, it is: Z=1.2X1+1.4X2+3.3X3+0.6X4+1.0X5 Where:
Total AssetsX2:
Retained Earnings / Total AssetsX3: EBIT / Total AssetsX4:
Market Value of Equity / Total LiabilitiesX5: Sales / Total Assets
Interpreting the Score
> 2.99: Low risk of bankruptcy (safe zone)1.81
< Z < 2.99: Moderate risk (gray zone)Z
< 1.81: High risk of bankruptcy (distress zone)
Uses in Business
Assessment: Investors and creditors use the Z-score to evaluate the
financial stability of companies and assess credit risk.Decision-Making:
Businesses use it for self-assessment, identifying financial weaknesses to
improve operational efficiency and solvency.Comparative
Analysis: The score helps compare financial health across firms,
industries, or over time.Mergers
& Acquisitions: Acquirers use the Z-score to assess the viability
of target companies.
Limitations
less accurate for non-manufacturing or newer businesses.Market
value dependence can make it volatile in fluctuating markets.
powerful tool for proactive financial management and decision-making. It can be one of the tools in your “tool set”
to analyze customers credit worthiness, targeting businesses to acquire, or
understanding your own company’s financial stability.