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what is Z-score??

Altman’s Z score is one of the best known, statistically derived predictive models used to forecast a firm’s impending bankruptcy . 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.

To test the model. . 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.e.HISTORY The Z-Score formula for predicting bankruptcy was published in 1968 by Edward Altman . half of which had filed for bankruptcy). Altman then calculated the Z-Scores for new groups of bankrupt and non bankrupt but sick firms (i. with reported deficits) in order to discover how well the Z-Score model could distinguish between sick firms and the terminally ill. an Assistant Professor of Finance at New York University. who was at the time. The original research was based on data from publicly held manufacturers (66 firms.

the model was found to be 80-90% accurate in predicting bankruptcy one year prior to the event. In subsequent tests over 31 years up until 1999. In 2009. used the Z-score to rank a basket of European companies. 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%. Morgan Stanley strategy analyst.Does the Altman Z-Score Work? In its initial test. Graham Secker. . the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event. He found that the companies with weaker balance sheets underperformed the market more than two thirds of the time.

Composition of z.score model .

99 -“Grey” Zones Z ≤ 1.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 ≥ 2.81 -“Distress” Zones .81 < Z < 2.99 -“Safe” Zones 1.

23 -“Distress” Zone .Zones of Discrimination: Z' ≥ 2.23 < Z' < 2.9 -“Safe” Zone 1. 9 -“Grey” Zone Z' ≤ 1.

1 -“Distress” Zone .1 < Z’’ < 2. 6 -“Grey” Zone Z’’ ≤ 1.6 -“Safe” Zone 1.Zones of discriminations: Z’’ ≥ 2.

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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 .To calculate Z-score .

these seven figures are used to create five financial ratios. Retained earnings /total assets C. Market capitalization /total liabilities E. Working capital / Total assets B. Sales / total sales . EBIT / total assets D. each identified by Altman as having the greatest forecasting power as to a company's financial strength: RATIOS : A.Together.

6*(D) + 1.0*(E) .4*(B) + 3.3*(C) + 0.2*(A) + 1.The third and final step is to use these ratios in the Z-score formula to create the final value: Z-score = 1.

It can be calculated as follows: Find Net Income.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. •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. then add back any interest expenses. •Total Assets is the total of the Assets section of the Balance Sheet. . add back any income tax expenses and subtract any income tax benefits.

The dates these values are chosen need not correspond exactly with the dates of the financial statements to which the market value is compared.•Market Value of Equity is the total value of all shares of common and preferred stock. •Net Worth is also known as Shareholders' Equity or. Equity. . •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. simply. It is equal to Total Assets minus Total Liabilities.

CALCULATION OF Z-SCORE MODEL : .

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. exercise caution. •Danger Zone (zone of ignorance.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. zone of uncertainty): Warning signals. •Failing Zone : High likelihood of bankruptcy within one year.

•Corporate Governance: Board of Directors and Audit Committee analysis of going concern capability. •Credit Evaluation: Loan officers and credit managers in accepting or rejecting loan applications. •Private Investment: Private equity.Z-Score users •Turnaround management: To develop emergency action plans and turnaround strategies to quickly correct a deteriorating situation. and analysis of merger and acquisition scenarios. •Insurance Underwriting: To evaluate the potential credit risk of the proposed insured including risk sharing and self-insured retentions. stockbrokers and individual investors to evaluate the relative safety of a proposed investment. consideration of corporate risk. .

So private firms can't use the Z Score. have a low asset turnover while grocery stores have a high turnover. for example. it could be biased in such a way that a healthy jewelry store looks sick and a sickly grocery store looks healthy. Jewelry stores. The other ratio is. if a firm is not publicly traded. One of these ratios is. Assets Turnover. its equity has no market value. . Obviously.Reasons for Multiple Versions : Two of the ratios have tended to limit the usefulness of the original Z Score measure. This ratio varies significantly by industry. the Market Value of Equity divided by Total Liabilities. But since the Z Score expects a value that is common to manufacturing.

It is instead a measure of how closely a firm resembles other firms that have filed for bankruptcy.How to Interpret the ZScore : 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 a measure of corporate financial distress. a measure of economic bankruptcy. .

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In more then 72% of the cases. it has been found to successfully predict corporate bankruptcy. • This model can be used to complement other analytical tools.Advantages of z-score model: • This model is considered to be highly accurate. • It is easy to calculate. • This model enables the analysts to incorporate many financial characteristics within a single score. .

• Its results do not stand to be that accurate in case of non-manufacturing firms.The Disadvantages of Z -score model: • It focuses only on financial data. • The results may turnout out to be inaccurate in case of a corruption of the financial data. . • Z score does not help the management to understand the dynamics of the problems existing in the company. • It is not useful for predicting company failure in the current scenario as it is based on out of date assumptions and data.

.• 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) : .

KFA Financials ( Rs. Cr ) PARTICULARS FY 11-12 Net sales EBIT Market value of equity Total assets Total liabilities Current assets Current liabilities Retained earnings 6360 (101) 1117 4106 9454 2974 4167 (5348) .

35 T2 T3 T4 T5 -1.6T4+0.82 -0.4T2+3.999 -1.64 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 .2 Z-SCORE -0.ALTMAN Z-SCORE (KFA) : FORMULA (Z)= 1.12 1.30 -0.2T1 +1.29 WEIGHTS 1.08 0.3 0.4 3.55 -0.02 0.3T3+0.07 1.999T5 FACTORS T1 RATIOS -0.55 TOTAL 1.6 0.

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