Altman Z-score Analysis

Altman Z-Score Bankruptcy Prediction Any single one of the 20 or so acknowledged financial ratios cannot adequately evaluate the overall strength of a company, although each of them can be extremely useful in identifying specific strengths and weaknesses that contribute to the general financial health of the firm. The Z-Score Bankruptcy Predictor combines several of the most significant variables in a statistically derived combination that was first published by Dr. Edward I. Altman in 1968 (See The Journal of Finance, September, 1968.) It was originally developed on a sampling of manufacturing firms. However, the algorithm has been consistently reported to have a 95 % accuracy of prediction of bankruptcy up to two years prior to failure on non manufacturing firms as well. There have been many other bankruptcy predictors developed and published. However, none has been so thoroughly tested and broadly accepted as the Altman Z-Score. The Altman Z-Score variables influencing the financial strength of a firm are: Entry your financial data

CA = CURRENT ASSETS

1,356,551

TA = TOTAL ASSETS

3,020,121

SL = NET SALES

3,605,561

TL = TOTAL LIABILITY

1,186,296

CL = CURRENT LIABILITIES VE = MARKET VALUE OF EQUITY

486,296 1,833,825

EBIT = EARNINGS BEFORE INTEREST AND TAXES

403,533

RE = RETAINED EARNINGS

283,825

THE ALTMAN Z-SCORE IS COMPUTED AS FOLLOWS: Computing Factor 1 X1 = CA – CL divided by TA X1 = $1,356,551 – $486,296 divided by $3,020,121 X1 = $870,255 divided by $3,020,121 X1 = .288 The least significant of factors, this is a measure of the net liquid assets of the firm in relation to total assets. CA – CL is known as Working Capital. Computing Factor 2 X2 = RE divided by TA X2 = $283,825 divided by $3,020,121 X2 = .094 A more significant factor. A measure of profitability over time. The Retained Earnings Account is subject to manipulation and a bias could be created. Earnings Account is subject to manipulation and a bias could be created. Computing Factor 4 X4 = VE divided by TL X4 = $1,833,825 divided by $1,186,296 X4 = 1.546

More significant than the former. An indication of the firm's ability to suffer a decline in value of assets. In closely held firms, VE may be substituted with (TA – TL). Users are cautioned that this is a proxy that has not been statistically verified. Computing Factor 5 X5 = SL divided by TA X5 = $3,605,561 divided by $3,020,121 X5 = 1.194 Next to the most significant factor. It illustrates the sales generating ability of the firm's assets. Computing Factor 3 X3 = EBIT divided by TA X3 = $403,533 divided by $3,020,121 X3 = .134 The most important factor. Profit is the principal objective and is the force that eventually determines the vitality of the firm. EBIT is Operating profit (gross profit less by operating expenses-OPEX). Combining the above to provide a numerical value that can indicate the strength of the firm we have: Z = (1.2 x X1) + (1.4 x X2) + (0.6 x X4) + (1.0xX5*) + (3.3 x X3) Z = (1.2 x 0.288) + (1.4 x 0.094) + (0.6 x 1.546) + (1.0 x 1.194*) + (3.3 x 0.134) Z = (0.346) + (0.132) + (0.928) + (1.194*) + (0.442) Z = 3.042

The Z-Score Bankruptcy Prediction calculated in this analysis is 3.042.

*Since Total Assets is the denominator of the X5 factor, small values here in relation to Sales can provide a ratio of large numerical value. The user is cautioned that values in excess of 3 to 1 may distort the predictor to provide an unwarranted favorable score. This may also be an indication that the firm is undercapitalized in order to support the sales volume attained. The analyst may wish to limit this ratio to 3 to 1, if inordinately high Z Scores are obtained on firms that otherwise indicate softness. Since the Z Score model is based on manufacturing firms, the result may be more useful as a trend indicator for other types of firms. But scores of less than 3.0 should be considered cause for serious inquiry. Other applications of the Z Score include use as one of the factors in the evaluation of the credit worthiness of a firm and a factor in selecting firms for stock and bond investment.

When Z is 3.0 or more, the firm is most likely safe based on the financial data. Of course, mismanagement, fraud, economic downturns, and other factors may cause an unexpected reversal. When Z is 2.7 to 3.0, the user is probably safe to predict survival, but this is a portion of the gray area and is below the threshold of relative safety.

When Z is 1.8 to 2.7, the firm is likely to be bankrupt within two years. This is the lower portion of the gray area and dramatic action may be required to effect survival.

When Z is Below 1.8, the firm is highly likely headed for bankruptcy. Rarely would a firm be expected to recover from a financial condition generating this or lower scores.

Spreadsheet courtesy of MYC Academy

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