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THE ALTMAN Z-SCORE
The ALTMAN Z-SCORE, developed in 1968 by Edward
I. Altman1, is a statistical estimator of financial distress
that has proven to be quite accurate over the years. The
estimator is comprised of five financial ratios that are
weighted and totaled to determine a single numerical estimate
of a firm’s overall solvency. The five ratios are:
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Working capital-to-total assets |
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Retained earnings-to-total assets |
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Earnings before interest & taxes (EBIT)-to-total
assets |
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Market value equity-to-book value of total
debt |
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Sales-to-total assets |
Firms that have a Z-Score more than 2.99 are
considered to be healthy, while firms that score less than
1.81 are considered
to be in a state of financial distress. Companies that score
between 1.81 and 2.99 fall into a gray area or a “zone
of ignorance”. The Altman Z-Score is an excellent predictor
of bankruptcy for up to two years prior to actual filings
for bankruptcy.
Over the time period, 1969 to 1999, between 80 and 90 percent
of the firms scored as in distress in a year actually failed
the following year. The model also correctly predicted failures
two years ahead about 70 percent of the time.
For more information on the Altman Z-Score,
go to http://pages.stern.nyu.edu/~ealtman/Zscores.pdf, where
you can download Professor Altman’s latest paper
on predicting financial distress of companies.
1 Edward I. Altman is the Max L. Heine Professor and Vice-Director
of New York University’s Salomon Center, Leonard
N. Stern School of Business.
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