Altman Z-score (Altman Z)
A five-factor bankruptcy model from 1968 combining liquidity, retained earnings, operating profitability, market value against debt, and asset turnover.
It is the most tested distress model in finance and it flags balance-sheet trouble before the market does.
How it is computed here
Z = 1.2 (working capital / assets) + 1.4 (retained earnings / assets) + 3.3 (EBIT / assets) + 0.6 (market cap / total liabilities) + 1.0 (revenue / assets)
Combines more than one basis. See the note. Four of the five terms come from the latest filed fiscal year. The fifth is today's market capitalisation over total liabilities, so the score falls when the share price falls, with nothing having changed on the balance sheet. Filed under health. Higher is the stronger reading, other things equal.
The readings, and where the lines come from
| Range | Reading |
|---|---|
| below 1.81 | Distress zone |
| 1.81 to 2.99 | Grey zone |
| 2.99 and above | Safe zone |
Altman (1968), Journal of Finance, original discriminant cutoffs.
When it misleads
- Estimated on manufacturers in the 1960s. It is not applicable to financial companies at all and is withheld for them.
- Contains a market-value term, so a falling share price pushes a company towards the distress zone on its own.
- It is a smoke detector, not a verdict. Most companies in the grey zone do not fail.
Not meaningful for banks, insurers, financial companies: the product prints n/m with the reason rather than a number for them.
Questions
How is altman z-score calculated?
Z = 1.2 (working capital / assets) + 1.4 (retained earnings / assets) + 3.3 (EBIT / assets) + 0.6 (market cap / total liabilities) + 1.0 (revenue / assets). Combines more than one basis. See the note. Four of the five terms come from the latest filed fiscal year. The fifth is today's market capitalisation over total liabilities, so the score falls when the share price falls, with nothing having changed on the balance sheet.
What does altman z-score tell a value investor?
It is the most tested distress model in finance and it flags balance-sheet trouble before the market does.
When does altman z-score mislead?
Estimated on manufacturers in the 1960s. It is not applicable to financial companies at all and is withheld for them. Contains a market-value term, so a falling share price pushes a company towards the distress zone on its own. It is a smoke detector, not a verdict. Most companies in the grey zone do not fail.