The Altman Z-Score
The Altman Z-Score is a quantitative balance-sheet method of determining a company’s financial health. “Safe” companies, i.e. companies that have a low probability of bankruptcy, have an Altman Z-Score greater than 3.0.
The Z-Score model is the 1960′s brainchild of Professor Edward Altman of NYU.
There are 5 variables:
- 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).
For Public Companies, the Model is calculated as follows:
- Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5.
The Interpretation of Altman Z-Score:
Z-SCORE ABOVE 3.0 –The company is considered ‘Safe’ based on the financial figures only.
Z-SCORE BETWEEN 2.7 and 2.99 – ‘On Alert’. This zone is an area where one should ‘Exercise Caution’.
Z-SCORE BETWEEN 1.8 and 2.7 – Good chance of the company going bankrupt within 2 years of operations from the date of financial figures given.
Z-SCORE BELOW 1.80- Probability of Financial Catastrophe is Very High.
If the Altman Z-Score is close to or below 3, then it would be as well to do some serious due diligence
on the company in question before even considering investing.