Altman Z Score
The Altman Z Score was designed to predict the probability that a company would go bankrupt within two years using financial metrics that assess solvency, profitability, leverage, liquidity, and turnover.
Today, we use it to help assess a company's fundamental quality.
Altman Z Score Formula
Use these factors:
X1 = Working Capital/Total Assets
X2 = Retained Earnings/Total Assets
X3 = EBITDA/Total Assets
X4 = Market Value of Equity/Total Liabilities
X5 = Net Sales/Total Assets
Altman Z Score for Manufacturers
Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5
Altman Z Score for Non-Manufacturers
Z = 6.56*X1 + 3.26*X2 + 6.72*X3 + 1.05*X4
Altman Z Score Interpretation
ORIGINAL Altman Z Score for Manufacturers
- When Z is 3.0 or more, the firm is most likely safe based on the financial data. However, be careful to double check as fraud, economic downturns and other factors could cause unexpected reversals.
- When Z is 2.7 to 3.0, the company is probably safe from bankruptcy, but this is in the grey area and caution should be taken.
- When Z is 1.8 to 2.7, the company is likely to be bankrupt within 2 years. This is the lower portion of the grey area and a dramatic turnaround of the company is needed.
- When Z is below 1.8, the company is highly likely to be bankrupt. If a company is generating lower than 1.8, serious studies must be performed to ensure the company can survive.
REVISED Altman Z Score for Non-Manufacturers
- When Z is 2.6 or more, the firm is most likely safe based on the financial data. However, be careful to double check as fraud, economic downturns and other factors could cause unexpected reversals.
- When Z is 1.1 to 2.6, the company is probably safe from bankruptcy, but this is in the grey area and caution should be taken.
- When Z is below 1.1, the company is highly likely to be bankrupt. If a company is generating lower than 1.8, serious studies must be performed to ensure the company can survive.
Z Score Analysis: General Points to Understand About Each Component
These are general pointers. Be sure to read the full discussion to see the pros and cons of each.
Working Capital / Total Assets (X1)
The more working capital there is compared to the total assets, the better the liquidity situation.
Retained Earnings / Total Assets (X2)
The lower the ratio, the company is funding assets by borrowing instead of through retained earnings.
EBITDA / Total Assets (X3)
EBITDA / Total Assets is a variation of ROA. Instead of net income, EBIT is used for the numerator. This ratio looks at the company’s ability to generate profits from its assets before deducting interest and taxes.
Market Value of Equity / Total Liabilities (X4)
This ratio is supposed to show you how much of the company’s market value could decline before liabilities exceed assets. If the stock price is high, then this ratio also goes up.
Net Sales / Total Assets (X5)
Simply asset turnover. The more money you can generate from assets, the better.
