Z-Score (Altman)

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Summary

Z-Score Bankruptcy AltmanThe Z-Score formula for predicting bankruptcy of Edward Altman is a multivariate formula for a measurement of the financial health of a company and a powerful tool to diagnose the probability that a company will go bankrupt within a 2 year period. Studies measuring the effectiveness of the Z-Score have shown the model is often accurate in predicting bankruptcy (72%-80% reliability).
 

The Z-Score was developed in 1968 by Dr. Edward I. Altman, Ph.D., a financial economist and professor at New York University's Stern School of Business.
 

Composition of the Z-Score

The Z-Score bankruptcy predictor combines five common business ratios, using a weighting system calculated by Altman. Thus it determines the likelihood that a company will go bankrupt. It was derived based on data from manufacturing firms, but has since proven to be also effective (with some modifications) in determining the risk that a services firm will go bankrupt.


Analyzing the results of the Z-Score method

How should the results be judged? It depends:

  • Original Z-Score [For Public Manufacturer] If the score is 3.0 or above - bankruptcy is not likely. If the Score is 1.8 or less - bankruptcy is likely. A score between 1.8 and 3.0 is the grey area. Probabilities of bankruptcy within the above ranges are 95% for one year and 70% within two years. Obviously, a higher score is desirable.
  • Model A Z'-Score [For Private Manufacturer] Model A of Altman's Z-Score is appropriate for a private manufacturing firm. You should not apply Model A to other companies. A score of 2.90 or higher indicates that bankruptcy is not likely. But a score of 1.23 or below is a strong indicator that bankruptcy is likely. Probabilities of bankruptcy in the above ranges are 95% for one year and 70% within two years. Obviously, a higher score is desirable.
  • Model B Z'-Score [For Private General Firm] Edward Altman developed this version of the Altman Z-Score to predict the likelihood that a privately owned non-manufacturing company will go bankrupt within one or two years. Model B is appropriate for a private general (non-manufacturing) firm. Model B should not be applied to other companies. A score of 1.10 or lower indicates that bankruptcy is likely, while a score of 2.60 or higher can be an indicator that bankruptcy is not likely. A score between the two is the gray area. Probabilities of bankruptcy in the above ranges are 95% for one year and 70% within two years. Again, obviously, a higher score is desirable.

For the Z-Score Formula, see the figure on the right. Note the variations for public and private companies.


Book: John B. Caouette, Edward I. Altman, Paul Narayanan - Managing Credit Risk


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Predicting Bankruptcy of SMEs
Altman Z.Score has been made for big companies but does not include SME. This kind of companies usually has different en (...)
10
 
Very High Z Score: Is a Z score of 1000 Possible?
Could a Z score potentially be 1000...? (...)
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2 comments
🔥 NEW Dynamic Aspects of Altman's Z-Score
How does Z-Score take into account the dynamic aspect of companies and economies?
(How) Is the model corrected for (...)
4
 
Various Ways to Calculate the Z-score?
I am doing a project in finance. I would like to know how manual calculations can be done in Z-Score method? (...)
4
 
2 comments
Z-scores Calculator for Spanish SMEs
I've prepared an automatic calculator for Altman's z-scores (dopplerp.com/financialviability). You'll notice there's a t (...)
4
 
Fault in the formula on this page
According to Altman's own article (find references on the English Z-score Wikipedia page) the ratio for X4 for private m (...)
4
 
Non-financial Factors in Prediction of Financial Distress
Financial distress management may lead to a successful turnaround of a firm if there would be timely detection of the sy (...)
3
 
Strengths and Weaknesses of Z-Score
Help me, who can tell me about the strength and weaknesses of z-score model? (...)
3
 
Applicability of Z Score to Financial Institutions?
I've read that the Altman Z score shouldn't be used for financial firms. Is this correct? Thank you. (...)
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Compare Z-Score model with these liquidity measurement ratios:  Current Ratio  |  Quick Ratio  |  Cash Ratio  |  Credit Risk Management


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