The Z-Score is a useful tool for recognizing the need

for a turnaround, determining the degree of

financial distress, and to see gauge whether a
turnaround plan will be feasible.
Altmans Z score is one of the best known, statistically derived predictive models
used to forecast a firms impending bankruptcy .
what is Z-score??
The Z-Score formula for predicting bankruptcy was published in 1968 by
Edward Altman , who was at the time, an Assistant Professor of Finance at New
York University.


The original research was based on data from publicly held manufacturers (66
firms, half of which had filed for bankruptcy). Altman calculated 22 common
financial ratios for all of them and then used multiple discriminant analysis to
choose a small number of those ratios that could best
distinguish between a bankrupt firm and a healthy one.
To test the model, Altman then calculated the Z-Scores
for new groups of bankrupt and non bankrupt but sick
firms (i.e. with reported deficits) in order to discover
how well the Z-Score model could distinguish between
sick firms and the terminally ill.



HISTORY
Does the Altman
Z-Score Work?

In its initial test, the Altman Z-Score was found to be 72% accurate in predicting
bankruptcy two years prior to the event. In subsequent tests over 31 years up until
1999, the model was found to be 80-90% accurate in predicting bankruptcy one
year prior to the event.

In 2009, Morgan Stanley strategy analyst, Graham Secker, used the Z-score to rank
a basket of European companies. He found that the companies with weaker
balance sheets underperformed the market more than two thirds of the time.
Morgan Stanley also found that a company with an Altman Z-score of less than 1
tended to underperform the wider market by more than 4%.

Composition of
z- score model
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


Zone of discrimination:
Z 2.99 -Safe Zones
1.81 < Z < 2.99 -Grey Zones
Z 1.81 -Distress Zones
Zones of Discrimination:

Z' 2.9 -Safe Zone
1.23 < Z' < 2. 9 -Grey Zone
Z' 1.23 -Distress Zone

Zones of discriminations:

Z 2.6 -Safe Zone
1.1 < Z < 2. 6 -Grey Zone
Z 1.1 -Distress Zone

To calculate Z-score , the first step is to identify
the seven items listed on the balance sheet and
income statement used in the calculation:


Working capital
Total assets
Total liabilities
Market capitalization
Sales
Earning before interest and taxes (EBIT)
Retained earning

Together, these seven figures are used to create
five financial ratios, each identified by Altman
as having the greatest forecasting power as to
a company's financial strength:

RATIOS :
A. Working capital / Total assets
B. Retained earnings /total assets
C. EBIT / total assets
D. Market capitalization /total liabilities
E. Sales / total sales


The third and final step is to use these ratios in
the Z-score formula to create the final value:

Z-score = 1.2*(A) + 1.4*(B) + 3.3*(C) + 0.6*(D) + 1.0*(E)
The Z Score Ingredients



The Z Score is calculated by multiplying each of several financial ratios by an
appropriate coefficient and then summing the results. The ratios rely on these
financial measures:

Working Capital is equal to Current Assets minus Current Liabilities.

Total Assets is the total of the Assets section of the Balance Sheet.

Retained Earnings is found in the Equity section of the Balance Sheet.

EBIT (Earnings Before Interest and Taxes) includes the income or loss from
operations and from any unusual or extraordinary items but not the tax effects of
these items. It can be calculated as follows: Find Net Income; add back any
income tax expenses and subtract any income tax benefits; then add back any
interest expenses.


Net Worth is also known as Shareholders' Equity or, simply, Equity. It is equal to
Total Assets minus Total Liabilities.

Book Value of Total Liabilities is the sum of all current and long-term
liabilities from the Balance Sheet.

Sales includes other income normally categorized as revenues in the firm's
Income Statement.
Market Value of Equity is the total value of all shares of common and
preferred stock. The dates these values are chosen need not correspond exactly
with the dates of the financial statements to which the market value is
compared.

CALCULATION OF Z-SCORE
MODEL :
Z-Score use

The Z-Score applies statistical techniques to financial ratios to determine the overall
health status of a business:

Healthy Zone: Business is in good shape.

Danger Zone (zone of ignorance, zone of uncertainty): Warning signals, exercise
caution.

Failing Zone : High likelihood of bankruptcy within one year.
Z-Score users

Turnaround management: To develop emergency action plans and turnaround
strategies to quickly correct a deteriorating situation.

Corporate Governance: Board of Directors and Audit Committee analysis of
going concern capability, consideration of corporate risk, and analysis of merger
and acquisition scenarios.

Credit Evaluation: Loan officers and credit managers in accepting or rejecting
loan applications.
Private Investment: Private equity, stockbrokers and individual investors to
evaluate the relative safety of a proposed investment.

Insurance Underwriting: To evaluate the potential credit risk of the proposed
insured including risk sharing and self-insured retentions.


Reasons for Multiple
Versions :

Two of the ratios have tended to limit the usefulness of the original Z Score
measure.

One of these ratios is, the Market Value of Equity divided by Total Liabilities.
Obviously, if a firm is not publicly traded, its equity has no market value. So private
firms can't use the Z Score.

The other ratio is, Assets Turnover. This ratio varies significantly by industry.
Jewelry stores, for example, have a low asset turnover while grocery stores have a
high turnover. But since the Z Score expects a value that is common to
manufacturing, it could be biased in such a way that a healthy jewelry store looks
sick and a sickly grocery store looks healthy.


How to Interpret the Z-
Score :





The Z Score is not intended to predict when a firm will file a formal declaration of
bankruptcy in a federal district court. It is instead a measure of how closely a firm
resembles other firms that have filed for bankruptcy. It is a measure of corporate
financial distress, a measure of economic bankruptcy.

Advantages of z-score
model:

This model is considered to be highly accurate. In more then 72% of the cases,
it has been found to successfully predict corporate bankruptcy.

It is easy to calculate.

This model can be used to complement other analytical tools.

This model enables the analysts to incorporate many financial
characteristics within a single score.
The Disadvantages of Z -score
model:


It focuses only on financial data.

Z score does not help the management to understand the dynamics of the
problems existing in the company.

The results may turnout out to be inaccurate in case of a corruption of
the financial data.

It is not useful for predicting company failure in the current scenario as
it is based on out of date assumptions and data.

Its results do not stand to be that accurate in case of non-manufacturing
firms.


The values of some quantitative ratios used in this model are prone to change
from time to time.

It is highly generalized in its approach.
APPLICATION OF Z-SCORE MODEL
TO KINGFISHER AIRLINES (KFA) :
PARTICULARS FY 11-12
Net sales 6360
EBIT (101)
Market value of equity 1117
Total assets 4106
Total liabilities 9454
Current assets 2974
Current liabilities 4167
Retained earnings (5348)
KFA Financials ( Rs. Cr )
FACTORS RATIOS WEIGHTS Z-SCORE
T1 -0.29 1.2 -0.35
T2 -1.30 1.4 -1.82
T3 -0.02 3.3 -0.08
T4 0.12 0.6 0.07
T5 1.55 0.999 1.55
TOTAL -0.64
ALTMAN Z-SCORE (KFA) :
FORMULA (Z)= 1.2T1 +1.4T2+3.3T3+0.6T4+0.999T5
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
OPEN FOR
QUERIES !!!
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