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 The
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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 Prediction of Financial Distress
Modeling a financial distress predictor
Financial distress management may lead to a successful turnaround of a firm if there would be timely detection of the symptoms of decline well in advance. On the other hand, some turnarounds do not succeed...
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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 type of calculation called 'Spanish Company'; that's because it has been prepared with Spanish companies data (the availability for...
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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 manufacturers and non-manufacturers should be:
Book value of equity/Book value of total liabilities
Please correct me if I'm ...
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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 environment, behavior and variables. What method can be used here to predict bankruptcy?...
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Z-Score (Altman) Special Interest Group
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Z-Score (Altman) Education & Events
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ZETA Model
The ZETA Model, also developed by Altman et al. (1977), is a more refined bankruptcy prediction model. The predictive accuracy of Altman’s Z-Sc...
Usage (application): Bankruptcy Prediction
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Altman’s Z-Score in Performance Management
Altman’s Z-Score has been very influential in areas such as credit risk analysis, distressed investing, Mergers & Acquisitions target analysis, and tu...
Usage (application): Performance Management and Value-based Management
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Modeling and Empirical Validation of Revised Altman’s Credit Risk Model for Indian Banks
The major cause of serious banking problems over the years continues to be directly related to lax credit standards for borrowers and counterparties, ...
Usage (application): Altman, Z-score, banks, default
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Z-Score Calculation Example
Tutorial on how to calculate Z scores. A z score measures the distance, in standard deviations, a specific observation is from the mean.
The form...
Usage (application): Z Score Tutorial, Z Score Calculation, Z Score Example
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Bankruptcy Likelyhood
Spreadsheet estimates the likelihood that a troubled firm will not survive, based upon bond ratings as well as bond prices....
Usage (application): Firm in distress
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Preparation to Z-score Calculation. Understanding Bell Curves
In this video an explanation of how to calculate Z-scores using a bell curve.
On a Bell curve, a Z-score measures the the distance (in standard d...
Usage (application): Z-Score Background, Statistics
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Z-Score Diagram
Download and edit this 12manage PowerPoint graphic for limited personal, educational and business use.
Republishing in intranets, websites, books, ma...
Usage (application): Bankruptcy Prediction
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Compare Z-Score model with these other liquidity measurement ratios:
Current Ratio |
Quick Ratio |
Cash Ratio |
RAROC
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