Altman Z-score

The Altman z-score is a measure of a company's financial strength that uses a weighted sum of several factors. Although it is sometimes referred to simply as z-score, this is can be ambiguous. It was devised by Edward I. Altman

Although many measures of financial strength exist the z-score is different to most in that it combines multiple factors, and has been proved to be successful as a predictor of bankruptcy.

The weightings used for each factor have changed significantly since they were first estimated in 1968. The original model was:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5

where:
X1 is working capital ÷ total assets
X2 is retained earnings (profit) ÷ total assets
X3 is EBIT ÷ total assets
X4 is market value of equity ÷ book value of debt
X5 is sales ÷ total assets

This is slightly different from the z-score as it appears in Altman's original paper because it uses fractions rather than percentages for each number: e.g. 0.2 rather than 20 for a ratio that is usually expressed as a percentage. The spurious accuracy of multiplying X5 by 0.999 instead of leaving it at one has also been omitted.

A more recent estimate by Altman (in 2000) is significantly different:

Z = 0.72X1 + 0.85X2 + 3.1X3 + 0.42X4 + X5

Once again, this has been rounded to two significant figures.

Altman's 2000 paper revisits the z-score and his proprietary zeta model.

Other single number measures of financial strength exist, including Piotroski's F-score.

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