Measuring the 'Fiscal-Fitness' of a company: The Altman Z-Score
(This Model of Z-Score is for Publicly Traded Firms. To learn about the Z'-Score Model for Private Firms Click Here)
Using Multiple Discriminant Analysis Edward Altman combined a set of 5 financial ratios to come up with the Altman Z-Score. This score uses statistical techniques to predict a publicly traded company's probability of failure using the following 8 variables from a company's financial statements:
{For Z Score the following 8 inputs are essential: {Current Assets; Current Liabilities; Total Liabilities; EBIT; Total Assets; Net Sales; Retained Earnings; Market Value of Equity}
The 5 financial ratios in the Altman Z-Score and their respective weight factor is as follows:
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RATIO
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WEIGHTAGE
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||
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A
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EBIT/Total Assets
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x. 3.3
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-4 to +8.0
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B
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Net Sales /Total Assets
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x 0.999
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-4 to +8.0
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C
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Market Value of Equity / Total Liabilities
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x 0.6
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-4 to +8.0
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D
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Working Capital/Total Assets
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x 1.2
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-4 to +8.0
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E
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Retained Earnings /Total Assets
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x1.4
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-4 to +8.0
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These five A to E ratios are multiplied by the weightage as above, and the results are added together to arrive at the Altman Z-Score.
Altman Z-Score = (A x 3.3) + (B x 0.99) + (C x 0.6) + (D x 1.2) + (E x 1.4)
The Interpretation of Z Score:
Z-SCORE ABOVE 3.0 -The company is safe based on these financial figures only.
Z-SCORE BETWEEN 2.7 and 2.99 - On Alert. This zone is an area where one should exercise caution.
Z-SCORE BETWEEN 1.8 and 2.7 - Good chances of the company going bankrupt within 2 years of operations from the date of financial figures given.
Z-SCORE BELOW 1.80- Probability of Financial embarassment is very high.
Use the following online Z-Score Insolvency Prediction Calculator to assess the probability of insolvency of a publicly traded company.
Note: To calculate the Z'-Score for a private firm (click here)
Calculator - Altman Z Score