The Altman Z-score is a formula that was created by Edward Altman in 1968. The score combines five different financial ratios in order to determine the fiscal health of a company. The formula can predict bankruptcy and failure that will occur, usually within a two-year time period.
Things You'll Need
- Financial statements
Calculating the score
In order to compute the Z-score you will need to gather the following information: Earnings before interest and taxes (EBIT), total assets, net sales, market value of equity, total liabilities, current assets, current liabilities, and retained earnings. All of that information will be found in the financial statements of a company.
The standard formula for Z score is: (Earnings before Interest/Total Assets x 3.3) + (Net Sales/Total Assets x .99) + (Market Value of Equity/Total Assets x 0.6) + (Working Capital/Total Assets x 1.2) + (Retained Earnings/Total Assets x 1.4). The total of that formula provides the Z score.
If the company has a Z score that falls above a 3.0, the company is said to be safe and has an excellent chance of being successful in the next few years. A score that is from 2.7 to 2.99 indicates the company should try to make changes to increase the score. Cutting back on expenses would be a good strategy. A score from 1.8 to 2.7 shows a good chance that the company will not survive financially and will probably file for bankruptcy within in the next two years. A score below 1.8 indicates financial failure is highly probable.
You can take the same figures and plug them into an online calculator. A good place to go is http://www.ironwoodadvisory.com/zscore.htm. A spreadsheet can also be created that has a formula embedded that will create the Z score for you. That can be accomplished in Microsoft Excel or some other spreadsheet software.