Formula

1. Public Ltd. Companies and Manufacturing Companies)

The formula for the Altman Z score is the weighted average of five financial ratios
pertaining to liquidity, productivity, leverage, and efficiency. Mathematically, it is
represented as,
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 0.99 X5
where,
 X1 = Working Capital / Total Assets, which is a Measure of Liquidity
 X2 = Retained Earnings / Total Assets, which Indicates Leverage
 X3 = Earnings before Interest and Taxes / Total Assets, which Measures
Productivity
 X4 = Market Value of Equity / Total Liabilities, which Captures the Effect of
Decline in Market Value
 X5 = Sales / Total Assets, which is a Measure of Asset Efficiency

2. Private Manufacturing Companies →

Z-Score = 0.717 × X1 + 0.847 × X2 + 3.107 × X3 + 0.42 × X4 + 0.998 × X5
For public manufacturing companies, the following rules serve as general benchmarks:
Z-Score Interpretation

> 2.99 Safe Zone – Low Likelihood of Bankruptcy

1.81 to 2.99 Grey Zone – Moderate Risk of Bankruptcy

< 1.81 Distress Zone – High Likelihood of Bankruptcy

For private non-manufacturing companies, the benchmarks are as follows:

Z-Score Interpretation

> 2.60 Safe Zone – Low Likelihood of Bankruptcy

1.10 to 2.6 Grey Zone – Moderate Risk of Bankruptcy

< 1.10 Distress Zone – High Likelihood of Bankruptcy

Example – #1
Let us take the example of a company named AJX Ltd. An investor is interested to
invest his money in the company and so wants to check the financial health of the
company based on Altman Z score. Help the investor with the following information
about the target company:

Solution:
 X1 , X2 , X3 , X4 , X5 is calculated as
X1 is Calculated as
X1 = Working Capital / Total Assets
 X1 = $4.00 Mn / $4.00 Mn
 X1 = 1.0

X2 is Calculated as
X2 = Retained Earnings / Total Assets
 X2 = $2.00 Mn / $4.00 Mn
 X2 = 0.5

X3 is Calculated as
X3 = Earnings before interest and taxes / Total Assets
 X3 = $8.00 Mn / $4.00 Mn
 X3 = 2.0

X4 is Calculated as
X4= Market Value of Equity / Total Liabilities
 X4 = $3.00 Mn / $1.00 Mn
 X4 = 3.0

X5 is Calculated as
X5 = Sales / Total Assets
 X5 = $16.00 Mn / $4.00 Mn
 X5 = 4.0

Altman Z Score is calculated by using the formula given below

Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 0.99 X5
Z = 1.2 * 1.0 + 1.4 * 0.5 + 3.3 * 2.0 + 0.6 * 3.0 + 0.99 * 4.0
Z = 14.26
Therefore, the Altman Z score for AJX Ltd is well above the score of 3.0 which indicates
that the company is highly unlikely to go bankrupt in the near future.

Example – #2
Let us take the example of Apple Inc. to calculate the Altman Z score. The following
information is available for 2018:

X1 is Calculated as
X1 = Working Capital / Total Assets
 X1 = $14.4 Bn / $365.7 Bn
 X1 = 0.04

X2 is Calculated as
X2 = Retained Earnings / Total Assets
 X2 = $45.8 Bn / $365.7 Bn
 X2 = 0.13

X3 is Calculated as
X3 = Operating income / Total Assets
 X3 = $70.9 Bn / $365.7 Bn
 X3 = 0.19

X4 is Calculated as
X4 = Market Value of Equity / Total Liabilities
 X4 = $962.0 Bn / $258.6 Bn
 X4 = 3.72

X5 is Calculated as
X5 = Sales / Total Assets
 X5 = $265.6 Bn / $365.7 Bn
  X5 = 0.73
Altman Z Score is calculated by using the formula given below
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 0.99 X5
Z = 1.2 * 0.04 + 1.4 * 0.13 + 3.3 * 0.19 + 0.6 * 3.72 + 0.99 * 0.73
Z = 3.81
Therefore, the Altman Z score for Apple Inc. indicates that the company is highly
unlikely to go bankrupt.

Altman Z-Score Calculation Example

Suppose a public manufacturing company is at risk of insolvency following several
periods of underperformance, particularly in terms of profitability.
Using the original z-score model, we’ll estimate the chance of bankruptcy of our
hypothetical company.
The following assumptions will be used for our modeling exercise.
Current Assets = $60 million
Current Liabilities = $40 million
Fixed Assets = $100 million
Net Income = $10 million
Dividends = $2 million
Sales = $60 million
COGS and SG&A = $40 million
P/E Multiple = 8.0x
Total Liabilities = $120 million

Given those initial assumptions, our next step is calculating the remaining inputs.
Working Capital = $60 million – $40 million = $20 million
Total Assets = $60 million + $100 million = $160 million
Retained Earnings = $10 million – $2 million = $8 million
Operating Income (EBIT) = $60 million – $40 million = $20 million
Market Capitalization = 8.0x × 10 million = $80 million
We can observe that the excess current assets barely cover the current liabilities.
As a manufacturing company, the company’s operations rely on significant purchases of
fixed assets (PP&E) – i.e. capital expenditures – as confirmed by the $100 million in fixed
assets.
Moreover, the company’s net margin is approximately 17%, with a dividend payout ratio
of 20%. If necessary, those dividend issuances would need to be halted soon.
While the operating margin and net margin are not necessarily poor, especially for the
manufacturing sector, the more concerning red flag is the low P/E multiple (and
market capitalization) – which suggests the market is not optimistic about the
company’s future growth and profitability.
Considering the low net income, the P/E multiple here could be misleading high, so the
8.0x – despite being a normal valuation multiple in most industries – should be
perceived negatively.
The inputs for our z-score calculation are the following:
X1 = Working Capital ÷ Total Asset = 0.13
X2 = Retained Earnings ÷ Total Assets = 0.05
X3 = EBIT ÷ Total Assets = 0.13
X4 = Market Capitalization ÷ Total Liabilities = 0.67
X5 = Sales ÷ Total Assets = 0.38

We then plug the inputs into our z-score formula:

 Z-Score = (1.20 × 0.13) + (1.40 × 0.05) + (3.30 × 0.13) + (0.60 × 0.67) + (0.99 × 0.38)
 Z-Score = 1.40
Since the z-score of 1.40 is below 1.81, our company is in the “Distress Zone,” where the
risk of near-term insolvency is high.