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# Altman Z-Score: A tool to predict likelihood of bankruptcy

September 12, 2010

#### sudhanshujain

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The Altman Z-Score is a measure of a company’s health and likelihood of bankruptcy. It was developed by Edward Altman in 1968 when he was a finance professor at NYU. This is a mathematical formula which uses financial data from company’s income statement and balance sheet. It generates a number which tells you the likelihood of bankruptcy or financial embarrassment. It has a reported 72% accuracy in predicting bankruptcies two years in advance.

Z-Score Formula for Public Companies:

T1 = Working Capital / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Market Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

Z-Score Bankruptcy Model:

Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5

Zones of Discrimination:

Z > 2.99 -“Safe” Zone

1.8< Z< 2.99 -“Grey” Zone

Z< 1.80 -“Distress” Zone

Old School Value has a spreadsheet for calculating Z score for any company by typing in a ticker of the company.

Z-Score Formula for Private Firms:

T1 = (Current Assets-Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

T5 = Sales/ Total Assets

Z' Score Bankruptcy Model:

Z' = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5

Zones of Discrimination:

Z' > 2.9 -“Safe” Zone

1.23< Z'< 2. 9 -“Grey” Zone

Z'< 1.23 -“Distress” Zone

Z-Score for Non Manufacturer Industrials and Emerging Market Credits:

T1 = (Current Assets-Current Liabilities) / Total Assets

T2 = Retained Earnings / Total Assets

T3 = Earnings Before Interest and Taxes / Total Assets

T4 = Book Value of Equity / Total Liabilities

Z-Score Bankruptcy Model:

Z = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

Zones of Discrimination:

Z > 2.6 -“Safe” Zone

1.1< Z< 2. 6 -“Grey” Zone

Z< 1.1 -“Distress” Zone

Reference:

Altman, Edward I. (July, 2000). "Predicting Financial Distress of Companies" http://pages.stern.nyu.edu/~ealtman/Zscores.pdf

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 Currently 3.69/512345 Rating: 3.7/5 (16 votes)

Simon2says - 2 years ago

Ok, but what scroe is considered "Healthy"? is it a score out of 10 or 100?
Augustabound - 2 years ago
Ok, but what scroe is considered "Healthy"? is it a score out of 10 or 100?

The O.P. tells you at the bottom of the article.

Zones of Discrimination:

Z > 2.99 -“Safe” Zone

1.8< Z< 2.99 -“Grey” Zone

Z< 1.80 -“Distress” Zone

DaveinHackensack - 2 years ago
Incidentally, for an example of incorporating the Altman models (in this case, the four-term Altman Z"-Score, for non-manufacturing companies) into investing, you can see my most recent market neutral trade, posted here last month: Long IMO, Short TRGL.