Definition
Developed by Edward Altman in 1968, the Z-Score combines five financial ratios weighted to predict bankruptcy risk within two years. Scores above 3.0 indicate safety, between 1.8-3.0 is a "grey zone," and below 1.8 suggests high bankruptcy risk. Despite its age, the Z-Score remains remarkably effective at identifying financially distressed companies.
functions Formula
Z = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
A=Working Capital/Total Assets, B=Retained Earnings/Total Assets, C=EBIT/Total Assets, D=Market Value Equity/Total Liabilities, E=Sales/Total Assets
lightbulb Example
A (working capital/assets) = 0.2, B (retained earnings/assets) = 0.3, C (EBIT/assets) = 0.15, D (market cap/liabilities) = 1.5, E (sales/assets) = 1.8. Z = 0.24 + 0.42 + 0.495 + 0.9 + 1.8 = 3.86. Score above 3.0 indicates low bankruptcy risk.
verified_user Key Points
- Above 3.0 = safe zone
- 1.8-3.0 = grey zone with moderate risk
- Below 1.8 = high bankruptcy risk
- 72% accuracy predicting bankruptcy 2 years in advance