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Measuring the 'Fiscal-Fitness' of a company:
The Altman Z-Score
In
the early 60's Edward Altman, using Multiple Discriminant Analysis
combined a set of 5 financial ratios to come up with the Altman
Z-Score. This score uses statistical techniques to predict a company's
probability of failure using the following 8 variables from a company's
financial statements:
The ones in Green are from the Income
Statement and the ones in Red from
the Balance Sheet
Use
the following Z-Score
Insolvency Prediction Calculator to
assess a company.
|
| 1.
Earnings
Before Interest & Taxes:EBIT |
| 2.
Total
Assets |
| 3.
Net
Sales |
| 4.
Market Value of Equity |
| |
| 5. Total
Liabilities |
| 6. Current
Assets |
| 7. Current
Liabilities |
| 8. Retained
Earnings |
|
|
|
The
5 financial ratios in the Altman Z-Score and their respective weight
factor is as follows:
|
|
RATIO
|
WEIGHTAGE
|
|
|
A
|
EBIT/Total
Assets
|
x.
3.3
|
-4
to +8.0
|
|
B
|
Net
Sales /Total Assets
|
x
0.999
|
-4
to +8.0
|
|
C
|
Market
Value of Equity / Total Liabilities
|
x
0.6
|
-4
to +8.0
|
|
D
|
Working
Capital/Total Assets
|
x
1.2
|
-4
to +8.0
|
|
E
|
Retained
Earnings /Total Assets
|
x1.4
|
-4
to +8.0
|
These
ratios are multiplied by the weightage as above, and the results
are added together.
Z-Score
= A x 3.3
+ B x 0.99 +
C x 0.6 + D
x 1.2 + E
x 1.4
The
Interpretation of Z Score:
Z-SCORE ABOVE 3.0 -The
company is safe based on these financial figures only.
Z-SCORE BETWEEN 2.7 and 2.99 -
On Alert. This zone is an area where one should exercise caution.
Z-SCORE BETWEEN 1.8 and 2.7 -
Good chances of the company going bankrupt within 2 years of operations
from the date of financial figures given.
Z-SCORE BELOW 1.80- Probability
of Financial embarassment is very high. |
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