Financial Metrics, Financial Tools

Z-Score: What is it and how can it protect your 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:

  • 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

  1. Risk Assessment: Investors and creditors use the Z-score to evaluate the financial stability of companies and assess credit risk.
  2. Decision-Making: Businesses use it for self-assessment, identifying financial weaknesses to improve operational efficiency and solvency.
  3. Comparative Analysis: The score helps compare financial health across firms, industries, or over time.
  4. 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:
  • X1: Working Capital /
    Total AssetsX2:
    Retained Earnings / Total AssetsX3: EBIT / Total AssetsX4:
    Market Value of Equity / Total LiabilitiesX5: 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, targeting businesses to acquire, or
    understanding your own company’s financial stability.

    Get started with The Numbers Navigator for your business today.