What is Altman Z SCORE?
Edward I. Altman published Altman Z score formula in 1968 for predicting bankruptcy of banks. The formula is used to predict the probability that a firm will go into bankruptcy within two years time horizon. Z-scores are used to predict corporate defaults and an easy-to-calculate control measure for the financial distress status of companies.
Objective of Altman Z score
· To determine the credit worthiness of a bank or financial institution
· To determine the risk associates with issuing any further loan
· To predict the chance of bankruptcy
· To know about the financial status of the organization
· To evaluate the business model and present strategy of the organization.
The Z score formula is
(Z-Score = A (1.2) + B(1.4) + C(3.3) + D(0.6) + E(.99))
Where:
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Objective |
Multiply |
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A |
Working Capital/Total Assets |
Measure the liquidity of the company’s asset base |
1.2 |
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B |
Retained Earnings/Total Assets |
Measure cumulative profitability relative to firm size |
1.4 |
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C |
Earnings before Interest & Tax/Total Assets |
Measure how efficiently the company uses its assets to generate earnings from operations |
3.3 |
|
D |
Market Value of Equity/Total Liabilities |
Consideration of the market’s view of the company relative to its liability |
.6 |
|
E |
Sales/Total Assets |
Measure asset turnover |
.99 |
How to interpret Z score
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Z score |
status |
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Z-SCORE ABOVE 3.0 |
Safe zone |
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Z-SCORE BETWEEN 2.7 and 2.99 |
On alert |
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Z-SCORE BETWEEN 1.8 and 2.7 |
Good chance of bankruptcy |
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Z-SCORE BELOW 1.80 |
Probability of Financial Catastrophe is Very High
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