Altman Z

Altman Z-Score:

The Altman Z-Score is a measure of a company’s health and the likelihood of bankruptcy, developed in the 1960’s by Edward Altman, a finance professor. The model was devised to warn investors about firms at risk of going bust, but it is also helpful in finding sectors and stocks best able to withstand the crunch. The Altman Z-Score is a quantitative formula that generates a number that tells you how likely a company is to head toward serious financial difficulty in a time frame of two years or less. The formula uses financial data from a company’s income statement and balance sheet to quickly tell you how concrete a company’s financial footing is. The formula is based on a company’s assets, earnings, revenue and market value.

There are 5 variables:

* X1 = (Working Capital/Total Assets).

* X2 = (Retained Earnings/Total Assets).

* X3 = (EBITDA/Total Assets).

* X4 = (Market Value of Equity/Total Liabilities).

* X5 = (Net Sales/Total Assets).

For Public Companies, the Model is calculated as follows:

* Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5.

Working Capital to Total Assets: Working capital is a company’s current assets less its current liabilities and measures a company’s efficiency and its short-term financial health. Positive working capital means that the company is able to meet its short-term obligations. Negative working capital means that a company’s current assets cannot meet its short-term liabilities; it could have problems paying back creditors in the short term, ultimately forcing it into bankruptcy. Companies with healthy, positive working capital shouldn’t have problems paying their bills.

Retained Earnings to Total Assets: The retained earnings of a company are the percentage of net earnings not paid out as dividends; they are “retained” to be reinvested in the firm or used to pay down debt. Retained earnings are calculated as follows: Beginning retained earnings + net income (net loss) – dividends paid....