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Altman Z-Score Analysis

Altman Z-Score Analysis

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Published by mc lim

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Categories:Types, Business/Law
Published by: mc lim on Jan 28, 2011
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07/15/2013

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Altman Z-Score Bankruptcy Prediction
Any single one of the 20 or so acknowledged financial ratios cannot adequately evaluate the overallstrength of a company, although each of them can be extremely useful in identifying specificstrengths and weaknesses that contribute to the general financial health of the firm.The Z-Score Bankruptcy Predictor combines several of the most significant variables in astatistically derived combination that was first published by Dr. Edward I. Altman in 1968 (Seemanufacturing firms. However, the algorithm has been consistently reported to have a 95 %accuracy of prediction of bankruptcy up to two years prior to failure on non manufacturing firmsas well. There have been many other bankruptcy predictors developed and published. However,none has been so thoroughly tested and broadly accepted as the Altman Z-Score. The AltmanZ-Score variables influencing the financial strength of a firm are:
Entry your financial data
CA = CURRENT ASSETS1,356,551TA = TOTAL ASSETS3,020,121SL = NET SALES3,605,561TL = TOTAL LIABILITY1,186,296CL = CURRENT LIABILITIES486,296VE = MARKET VALUE OF EQUITY1,833,825EBIT = EARNINGS BEFORE INTEREST AND TAXES403,533RE = RETAINED EARNINGS283,825
THE ALTMAN Z-SCORE IS COMPUTED AS FOLLOWS:
Computing Factor 1
X1 = $1,356,551 – $486,296 divided by $3,020,121X1 = $870,255 divided by $3,020,121
X1 = .288
The least significant of factors, this is a measure of the net liquid assets of the firm in relation to
Computing Factor 2
X2 = RE divided by TAX2 = $283,825 divided by $3,020,121
X2 = .094
A more significant factor. A measure of profitability over time. The Retained Earnings Accountis subject to manipulation and a bias could be created. Earnings Account is subject tomanipulation and a bias could be created.
Computing Factor 4
X4 = VE divided by TLX4 = $1,833,825 divided by $1,186,296
X4 = 1.546
The Journal of Finance
, September, 1968.) It was originally developed on a sampling of X1 = CA – CL divided by TAtotal assets. CA – CL is known as
Working Capital 
.
 
More significant than the former. An indication of the firm's ability to suffer a decline in value of assets. In closely held firms, VE may be substituted with (TA – TL). Users are cautioned thatthis is a proxy that has not been statistically verified.
Computing Factor 5
X5 = SL divided by TAX5 = $3,605,561 divided by $3,020,121
X5 = 1.194
Next to the most significant factor. It illustrates the sales generating ability of the firm's assets.
Computing Factor 3
X3 = EBIT divided by TAX3 = $403,533 divided by $3,020,121
X3 = .134
The most important factor. Profit is the principal objective and is the force that eventuallydetermines the vitality of the firm. EBIT is Operating profit (gross profit less by operatingexpenses-OPEX). Combining the above to provide a numerical value that canindicate the strength of the firm we have:
Z = (1.2 x X1) + (1.4 x X2) + (0.6 x X4) + (1.0xX5*) + (3.3 x X3)
Z = (1.2 x 0.288) + (1.4 x 0.094) + (0.6 x 1.546) + (1.0 x 1.194*) + (3.3 x 0.134)Z = (0.346) + (0.132) + (0.928) + (1.194*) + (0.442)Z = 3.042
The Z-Score Bankruptcy Prediction calculated in this analysis is 3.042.
*Since Total Assets is the denominator of the X5 factor, small values here in relation to Sales canprovide a ratio of large numerical value. The user is cautioned that values in excess of 3 to 1 maydistort the predictor to provide an unwarranted favorable score. This may also be an indication thatthe firm is undercapitalized in order to support the sales volume attained. The analyst may wish tolimit this ratio to 3 to 1, if inordinately high Z Scores are obtained on firms that otherwise indicatesoftness. Since the Z Score model is based on manufacturing firms, the result may be more usefulas a trend indicator for other types of firms. But scores of less than 3.0 should be consideredcause for serious inquiry.Other applications of the Z Score include use as one of the factors in the evaluation of the creditworthiness of a firm and a factor in selecting firms for stock and bond investment.mismanagement, fraud, economic downturns, and other factors may cause an unexpectedreversal.gray area and is below the threshold of relative safety.
When Z is 3.0 or more
, the firm is most likely safe based on the financial data. Of course,
When Z is 2.7 to 3.0
, the user is probably safe to predict survival, but this is a portion of the

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