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
 SBI-PNB-HDFC-ICICI
Altman’s Z Score Comparison

Altman’s Z-score =
(1.2 × Working Capital/Total Assets) Z-score Probability of Bankruptcy
+ (1.4 × Retained Earnings/ Total Assets) 1.80 or less Very high
+ (3.3 × Operating Income/Total Assets) 1.81 to 2.99 Not sure
+ (0.6 × Market Value Of Common And Preferred Stock / Total 3.0 or greater Very low
Liabilities)
+ (1.0 × Net Sales / Total Assets)

Lower ratios indicate higher probabilities of

bankruptcy.

Z Scores are calculated for manufacturing based

companies and therefore the Z-score result will be
slightly lenient for financial banks as their business
model operates on heavy liabilities, loans and
investments.
 Altman Z score
1. Calculated on FY
2018 17-18 financial
5.50 statement.

4.50

2. Greater than 3
3.50
is considered safe.
3.00
5.34
2.50

3.40
1.50
2.37

1.30 1.16
0.50

Muthoot Finance Aditya Birla Capital Mahindra & Max Financial Reliance capital Ltd.
Ltd. Mahindra Financial
(0.50) services Ltd.

Series1 Series2
 4 years Altman Z score Analysis

Muthoot Finance Mahindra & Mahindra Financial Services

2.50
1.35

2.00 1.30

1.25
1.50
1.20

1.00 1.15

1.10
0.50
1.05
2014.5 2015 2015.5 2016 2016.5 2017 2017.5 2018 201
-
2014.5 2015 2015.5 2016 2016.5 2017 2017.5 2018 2018.5

Reliance Capital Ltd.

Max Financial 1.17
8.00 1.16
7.00 1.15
6.00 1.14
5.00 1.13
4.00 1.12
3.00 1.11
2.00 1.10
1.00 1.09
- 1.08
2014.5 2015 2015.5 2016 2016.5 2017 2017.5 2018 2018.5
1.07
2018 2017 2016 2015
JOURNEY OF AVIATION INDUSTRY
 S.no. Coefficient Description Value Amount

1.0 1.20 Working Capital/ Total Assets

-1624.07 1676.81 -1.16
2.0 1.40 Retained Earnings/Total Assets
-642.42 1676.81 -0.54
3.0 3.30 Operating Income/Total Assets
891.04 1676.81 1.75
4.0 0.60 Market Value of Common Stock/Total Liabilities
599.45 1676.81 0.21
5.0 1.00 Net Sales/Total Assets
7795.09 1676.81 4.65

          4.92

Observations: Since the score observed above (4.92) is more than 3.0, the probability of the
company going bankrupt is very low. The major contributor to achieve this number is the
ratio of Net sales to Total Assets
ALTMAN’S Z SCORE:
Equation
Altman’s Z-score =
Z-score Probability of bankruptcy
(1.2 × Working Capital/Total Assets)
+ (1.4 × Retained Earnings/ Total Assets) 1.80 or less Very high
+ (3.3 × Operating Income/Total Assets)
1.81 to 2.99 Not sure
+ (0.6 × Market Value Of Common And Preferred Stock / Total Liabilities )
+ (1.0 × Net Sales / Total Assets) 3.0 or greater Very low
 S.no. Coefficient Description Value Amount

1.0 1.20 Working Capital/ Total Assets

2375.94 14848.18 0.19
2.0 1.40 Retained Earnings/Total Assets
6687.16 14848.18 0.63
3.0 3.30 Operating Income/Total Assets
3976.64 14848.18 0.88
4.0 0.60 Market Value of Common Stock/Total Liabilities
384.41 14848.18 0.02
5.0 1.00 Net Sales/Total Assets
23020.89 14848.18 1.55

          3.27

Observations: Since the score observed above (3.27) is more than 3.0, the probability of
the company going bankrupt is very low. The major contributor to achieve this number is
the ratio of Net sales to Total Assets
ALTMAN’S Z SCORE:
Equation
Altman’s Z-score =
Z-score Probability of bankruptcy
(1.2 × Working Capital/Total Assets)
+ (1.4 × Retained Earnings/ Total Assets) 1.80 or less Very high
+ (3.3 × Operating Income/Total Assets)
1.81 to 2.99 Not sure
+ (0.6 × Market Value Of Common And Preferred Stock / Total Liabilities )
+ (1.0 × Net Sales / Total Assets) 3.0 or greater Very low
Altman’s Z-score
Conclusion Altman's Z Score
• Altman’s Z-score measures the 12 10 13
10
probability of bankruptcy; 11
• For both, Sun Pharma and Cipla, its
above 3.0 representing very low 11 10
11
9
probability of bankruptcy; 6

• However, few firms in the industry

2.95 2.97 3.00 2.81
would have low Z-score there by 2.29

resulting in industry score to be less MAR 14 MAR 15 MAR 16 MAR 17 MAR 18

than 3.0. Industry Sun Pharma Cipla

15