Altman Z-Score Model


Altman's Z-Score Model
is a numerical calculation that predicts whether a company will go bankrupt in the next two years. Edward Altman, an American finance professor, created the model in 1968 to measure a company's financial health.

Using several balance sheet values and corporate income, Altman's Z-score model is regarded as an excellent means of predicting the degree of the financial crisis of any firm. During the Great Depression, when firms witnessed a dramatic increase in defaults, Altman came up with the notion of constructing a formula for forecasting bankruptcy.

Example of Altman Z-Score Model:

One can calculate the Altman Z-score as follows:

Altman Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Where:

  • A = working capital / total assets
  • B = retained earnings / total assets
  • C = earnings before interest and tax / total assets
  • D = market value of equity / total liabilities
  • E = sales / total assets
Why is Altman Z-Score Model important?

The Z-Score Model is used to assess a company's financial health and estimate the likelihood of a company's failure within two years. Forecasting bankruptcy has been quite accurate in various scenarios and marketplaces. Defaults have several repercussions.

Topics: ACCA, CIMA, CPD, AAT, FRM