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A method to estimate a bankruptcy prediction for a company.[sc:kit02 ]
Altmans Z Score Formula
Explanation of Altmans Z Score
Altman’s Z-Score formula weighs five ratios then adds them together to come up with a bankruptcy prediction estimate for a company. This estimate of bankruptcy for publicly-held companies depends on the resulting score of Altman’s Z-Score formula, which the score is divided into four categories:
Less than 1.8: Bankruptcy risk is high
Between 1.8 and 2.7: Bankruptcy risk is fair
Between 2.7 and 3.0: Bankruptcy risk is possible, but not likely in the near-future
Higher than 3.0: Bankruptcy risk is low
Importance of Altmans Z Score
A score greater than 3.0, or an increasing Altman’s Z-Score is usually a positive sign. The higher the score, the better the company’s chances of avoiding bankruptcy, but this score should be checked against other companies and industry standards. It should be noted that large economic events, like an entire industry slowdown, would render this scoring method less accurate. The individual components of this formula should be monitored, as they are the key to understanding how the score was calculated.