Altman’s Z-score

Using Altman’s Z-score to Determine

the Probability of Bankruptcy
 Equation
 Altman’s Z-score =
 (1.2 × Working Capital/Total Assets)
 + (1.4 × Retained Earnings/ Total Assets)
 + (3.3 × Operating Income/Total Assets)
 + (0.6 × Market Value Of Common And Preferred Stock / Total Liabilities)
 + (1.0 × Net Sales / Total Assets)

Altman developed a series of formulas to determine the likelihood of business

failure because of low liquidity and inadequate earnings.
When to use indicator:
 Managers, investors, and creditors can use this formula to
determine if a company is likely to fail because of an
inappropriate amount of liquid assets or because of
ineffective operations which generate little or no income
and retained earnings. You should compare Z-scores to
companies of similar size and in similar industries because
acceptable standards can vary significantly.
 Altman developed his original Z-score model for smaller
sized manufacturers. Several modified formulas have been
developed for increased accuracy when analyzing
privately held firms or nonmanufacturing companies.
Meaning of result:
 Lower ratios indicate higher probabilities of bankruptcy.
Z-scores tend to trend lower prior to bankruptcy.

Z-score Probability of bankruptcy

1.80 or less Very high
1.81 to 2.99 Not sure
3.0 or greater Very low
Ways to improve the indicator:
 Increasing short-term assets such as cash and marketable
securities can increase the Z-score.
 Turning around operations to generate positive and
healthy operating income and retained earnings can also
move the Z-score in a positive direction.
Example
 Working capital = 44,135 − 12,032 = 32,103
 Total assets = 56,268
 Retained earnings = 18,722
 Operating income = 9,433
 Market value of common stock = 3,600 shares × $22.50
/ share = 81,000
 Market value of preferred stock = 15 shares × $25.00 /
share = 375
 Total liabilities = 25,180
 Net sales = 85,420
 Altman’s Z-score = (1.2 × 32,103/56,268) + (1.4 ×
18,722 / 56,268) + (3.3 × 9,433 / 56,268) + (0.6 × 81,375 /
25,180) + (1.0 × 85,420 / 56,268) = 0.6846 + 0.4658 +
0.5532 + 1.939 + 1.5181 = 5.161
Sector Mid to large cap POB
Manufacturing General Motors 1.62
Retail Wal-Mart Stores 6.93
Food McDonald’s 5.07
Technology Microsoft 30.55
Finance Morgan-Stanley Dean Witter 0.41
Healthcare Columbia/HCA Healthcare 2.24
Service Manpower 4.71
Media/Publishing McGraw Hill 4.16

Sector Small to mid cap POB

Manufacturing Toro 3.39
Retail Bed Bath & Beyond 17.99
Food Applebee’s Int’l 7.38
Technology Cypress Semiconductor 2.94
Finance Franklin Resources 8.85
Healthcare Novacare 2.79
Service Air & Water Technologies –1.01
Media/Publishing Scholastic 3.01

Sector Micro to small cap POB

Manufacturing Encad 7.46
Retail TCBY Enterprises 8.27
Food Garden Fresh Restaurant 3.26
Technology Jmar Technologies 8.11
Finance AmeriTrade Holding 0.71
Healthcare National Home Health Care 11.4
Service Market Facts 5.64
Media/Publishing Thomas Nelson 3.08