Z-Score (Altman)

Knowledge Center

Predicting bankruptcy. Explanation of Z-Score formula of Altman. ('68)

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 -

Special Interest Group - Z-Score (Altman) Special Interest Group (138 members)

Forum - Z-Score (Altman)   Here you will find interesting and educational discussions.   Predicting Bankruptcy of SMEs Altman Z.Score has been made for big companies but does not ...           Very High Z Score: Is a Z score of 1000 Possible? (2 reactions) Could a Z score potentially be 1000...?...           Various Ways to Calculate the Z-score? (2 reactions) I am doing a project in finance. I would like to know how           Z-scores Calculator for Spanish SMEs I've prepared an automatic calculator for Altman's z-scores ...           Fault in the formula on this page According to Altman's own article (find references on the En...           Dynamic Aspects of Altman's Z-Score How does Z-Score take into account the dynamic aspect of com...           Non-financial Factors in Prediction of Financial Distress Financial distress management may lead to a successful turna...           Strengths and Weaknesses of Z-Score Help me, who can tell me about the strength and weaknesses o...           Applicability of Z Score to Financial Institutions? (2 reactions) I've read that the Altman Z score shouldn't be used for fina...

Best Practices - Z-Score (Altman) Here you will find the most valuable ideas.

Expert Tips - Z-Score (Altman) Here you will find high-quality advice from experts.   ZETA Model Bankruptcy Prediction...       Altman’s Z-Score in Performance Management Performance Management and Value-based Management...

Resources - Z-Score (Altman) Here you will find powerpoint presentations, micro-learning videos and further information sources. Modeling and Empirical Validation of Revised Altman’s Credit Risk Model for Indian Banks Altman, Z-score, banks, default...   Z-Score Calculation Example Z Score Tutorial, Z Score Calculation, Z Score Example...   Bankruptcy Likelyhood Firm in distress...   Preparation to Z-score Calculation. Understanding Bell Curves Z-Score Background, Statistics...   Z-Score Diagram Bankruptcy Prediction...     News about Z-score Altman         News about Z-score Bankruptcy         Videos about Z-score Altman         Videos about Z-score Bankruptcy         Presentations about Z-score Altman         Presentations about Z-score Bankruptcy         Books about Z-score Altman         Books about Z-score Bankruptcy         More about Z-score Altman         More about Z-score Bankruptcy

Compare Z-Score model with these other liquidity measurement ratios:  Current Ratio  |  Quick Ratio  |  Cash Ratio  |  RAROC

Return to Management Hub: Finance & Investing 

More Management Methods, Models and Theory