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# Altmans Z-score

#### IndianMoney.com Research Team | Updated On Saturday, September 27,2014, 12:21 PM

5.0 / 5 based on 1 User Reviews

### What It Measures

The z-score is a measure of the financial health of a company. The score uses statistical techniques to predict the likelihood that a company will fail because of bankruptcy within two years.

### Why It Is Important

Since the 1980s, auditors have used the z-score to help identify companies with serious cash problems. The measure is also used to help score applicants for loans. Stockbrokers commonly use the z-score to determine if a company is a good investment.

### How It Works in Practice

The z-score combines five common business ratios and uses a weighting system devised by Altman to produce a score somewhere between -4 and +8. Each of the components that make up the final z-score is rated independently, and each component has a different weight in the calculation of the overall z-score. The exact emphasis on each factor can vary slightly from one industry to another, using more specific z-score calculators.

All the information needed to calculate a z-score is available in company financial reports. The original formula to calculate a z-score is as follows :

z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + 0.999T5

Where
T1=Working capital/Total assets
T2 = Retained Earnings/Total Assets
T3 = EBIT/Total Assets
T4 = Market value of equity/book value of total liabilities
T5 = Sales/Total Assets

### Analysis

A score can be analyzed as follows :
>2.99: the company is considered "safe"
1.8–2.99: there is some risk of financial distress
<1.8: there is serious risk of financial distress

### Importance of Z-Score

• Although the numbers that go into the z-score can be influenced by external events, it is a useful tool to provide a quick analysis of where a company stands compared to competitors, and for tracking the risk of insolvency over time.
• Studies have shown the z-score is an accurate prediction of company failure rates in between seven and eight out of 10 cases.
• The formula was originally devised to be use public companies, but amendments have since been made to allow z-scores to be calculated for privately held companies. In this case, the calculation that should be used is as follows :

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## IndianMoney.com Research Team

The research team at IndianMoney.com comprises of certified and experienced professionals who share the company's vision to make every Indian financially literate by equipping every Indian with right and unbiased advice. IndianMoney.com research team provides newsletters, articles, videos and FAQs on various financial products and concepts only to help you make wise financial decisions.

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