Z-Score

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Altman’s Z-Score (Edward Altman) determines how likely a company is to fail.  In general, the lower the score, the higher the chance of bankruptcy. For example, a Z-Score above 3.0 indicates financial soundness; below 1.8 suggests a high likelihood of bankruptcy.  In general, the lower the score, the higher the chance of bankruptcy.  The Altman Z-Score has a 72% success rate of predicting bankruptcy within 2 years.

The Standard Z-Score

Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6) + ([Sales/ Total Assets] x 0.999)

Z-Score for Private Companies

A revised Z-Score formula for private companies was developed in 2002. The private company version weights the variables differently and uses book value of equity in place of market capitalization.

Z-Score = ([Working Capital / Total Assets] x 0.717) + ([Retained Earnings / Total Assets] x 0.847) + ([Operating Earnings / Total Assets] x 3.107) + ([Book Value of Equity / Total Liabilities] x 0.420) + ([Sales / Total Assets] x 0.998)

Z-Score for Non-Manufacturers

The Non-Manufacturers Z-score excludes the last component (sales / total assets) because Altman wanted to minimize the effects of manufacturing-intensive asset turnover.

Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6)

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