Knowledge Centre
Altman Z Score
American Professor Edward Altman developed the Altman Z-score formula in 1967. It was officially published in 1968. Over the years, Altman has continued to reevaluate his Z-score. From 1969 until 1975, Altman looked at 86 companies in distress, then 110 from 1976 to 1995, and finally 120 from 1996 to 1999, finding that the Z-score had an accuracy of predicting bankruptcy between 82% and 94%.
In 2012, he released an updated version called the Altman Z-score Plus that one can use to evaluate public and private companies, manufacturing and non-manufacturing companies, and U.S. and non-U.S. companies. One can use Altman Z-score Plus to evaluate corporate credit risk. The Altman Z-score has become a reliable measure of calculating credit risk.
As well as being a credit strength test, it can be an indicator of a company’s likelihood of distress or failure. The score is based on 5 financial ratios that can be calculated from the data found in a company’s Annual Report and Accounts.
Z-Score = 1.2A + 1.4B + 3.3C + + 0.6D + 1.0E
A = working capital / total assets
B = retained earnings / total assets
C = earnings before interest and tax / total assets D = market capitalization / total liabilities
E = sales / total assets
A score below 1.8 means potential failure, while 3 and above suggests a company in robust financial health and unlikely to imminently fail.
We at TEAM recognise the Z-score is not perfect and needs to be calculated and interpreted with care. The Z-score cannot compensate for manipulated or false accounting data. Companies in stress may be tempted to manipulate their financials. The Z-score is only as accurate as the data that goes into it.
The Z-score also has limitations, particularly when applied to infant companies with little to no earnings. These companies, regardless of their financial health, will score poorly.