The Altman Z-Score is a bankruptcy prediction model developed by Dr. Edward I. Altman of New York's

University in the mid-1960's. The model assigns a coefficient to five financial ratios, the numerical

values of which are added together to arrive at the Z-Score The score is then compared to the scale

below as an analytical tool to predict the probability of a company going bankrupt. If you have a

business and you are you experiencing financial difficulties and want to know what shape your business

is in we highly recommend you use the Z-Score calculator to give you an indication of the health of a

business. This calculator should be used over a number of periods to get a more accurate picture

Any single one of the 20 or so acknowledged financial ratios cannot adequately evaluate the overall

strength of a company, although each of them can be extremely useful in identifying specific strengths

and weaknesses that contribute to the general financial health of the firm.

The Z-Score Bankruptcy-Predictor combines several of the most significant variables in a statistically

derived combination that was first published by Dr. Edward I. Altman in 1968 (See The Journal of

Finance, September, 1968.) It was originally developed on a sampling of manufacturing firms.

However, the algorithm has been consistently reported to have a 95 % accuracy of prediction of

bankruptcy up to two years prior to failure on non manufacturing firms as well. There have been many

other bankruptcy predictors developed and published. However, .none has been so thoroughly tested

and broadly accepted as the Altman Z-Score. The Altman Z-Score variables influencing the financial

strength of a firm are:

CA = CURRENT ASSETS
TA = TOTAL ASSETS
SL = NET SALES
IN = INTEREST
TL = TOTAL LIABILITY
CL = CURRENT LIABILITIES
VE = MARKET VALUE OF EQUITY
ET = EARNINGS BEFORE TAXES
RE= RETAINED EARNINGS

X1 = CA-CL divided by TA

The least significant of factors, this is a measure of the net liquid assets of the firm in relation to

totalassets. CA - CL is known as Working Capital.

X2 = RE divided by TA

A more significant factor. A measure of profitability over time. The Retained Earnings Account is

subject to manipulation and a bias could be created.

X4 = VE divided by TL

More significant than the former. An indication of the firm's ability to suffer a decline in value of assets.

In closely held firms, VE may be substituted with (TA - TL). Users are cautioned that this is a proxy

that has not been statistically verified.

X5 = SL divided by TA

Next to the most significant factor. It illustrates the sales generating ability of the firm's assets.

X3 = ET + IN divided by TA

The most important factor. Profit is the principal objective and is the force that eventually determines

the vitality of the firm. Interest is added to the earnings as this cost does not detract from the earning

power of the firm. Combining the above to provide a numerical value that can indicate the strength of

the firm we have:

Z = 1.2xX1 + 1.4xX2 + 0.6xX4 + 1.OxX5* + 3.3xX3

The Z-Score calculated for Generic Retail is 8.50.

When Z is: the firm is:

3.0 or more, most likely safe based on the financial data. Of course, mismanagement, fraud, economic

downturns, and other factors may cause an unexpected reversal.

2.7 to 3.0,
Probably safe to predict survival, but this is a portion of the gray area and is below the threshold of

relative safety.

1.8 to 2.7
Likely to be bankrupt within two years. This is the lower portion of the gray area and dramatic action

may be required to effect survival.

Below 1.8
Highly likely headed for bankruptcy. Rarely would a firm be expected to recover from a financial

condition generating this or lower scores.

Since Total Assets is the denominator of the X5 factor, small values here in relation to Sales can

provide a ratio of large numerical value. The user is cautioned that values in excess of 3 t o 1 may

distort the predictor to provide an unwarranted favorable score. This may also be an indication that

the firm is under-capitalized in order to support the sales volume attained. The analyst may wish to

limit this ratio to 3 to 1, if inordinately high Z Scores are obtained on firms that otherwise indicate

softness. Since the Z Score model is based on manufacturing firms, the result may be more useful as

a trend indicator for other types of firms. But scores of less than 3.0 should be considered cause for

serious inquiry.

Other applications of the Z Score include use as one of the factors in the evaluation of the credit

worthiness of a firm and a factor in selecting firms for stock and bond investment.

The worksheet will indicate: The short-term potential for financial problems at your company.

Check your Z-Score: How's your Fiscal Fitness?

Publicly Held Firm

Please Note: Altman's Publicly Held model is probably the classic of this genre. The original data

sample consisted of 66 firms, half of which had filed for bankruptcy under Chapter 7. All businesses in

the database were manufacturers, and small firms with assets of less than $1 million were eliminated.

The Z score has proven successful in the real world. It correctly predicted 72% of bankruptcies two

years prior to the event. Z score profiles for failing businesses often indicate a consistent downward

trend as they approach bankruptcy.

Privately Held Firm

Please Note: If a firm's stock is not publicly traded, the (Market Value of Equity/Book Value of Debt)

ratio cannot be calculated. To correct for this problem, the Z score can be re-estimated using book

values of equity. Altman recommends the following alterations to the ratio weight factors.

Small Business,Service,Retails Sales,or Wholesaler

Please Note: The (Sales/Total Assets) ratio is believed to vary significantly by industry. It is likely to

be higher for merchandising and service firms than for manufacturers, since the former are typically

less capital intensive. Consequently, non-manufacturers would have significantly higher asset turnover

and Z scores. The model is thus likely to under predict certain sorts of bankruptcy. To correct for this

potential defect, Altman recommends that the (Sales/Total Assets) ratio be eliminated with

corresponding changes in the remaining ratios.

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