Z-Score

1: What's the Z-Score
Z-score formula for Predicting Bankruptcy of Edward Altman is a multivariate for a measurement of the financial health of a company and a powerful diagnostic tool that forecase the probability fo a company entering bankruptcy within 2 year period. Studies measuring the effectiveness of the Z-Score have shown the model is often accurate in predicting bankruptcy(72%-80% reliability).

2: Z-Score history
The Z-Score was developed in 1968 by Dr. Edward I. Altman, Ph.D., a financial economist and professor at New York University's Stern School of Business.

The Z-Score bankruptcy predictor combines five common business ratios, using a weighting system calculated by Altman to determine the likelihood of a company going bankrupt. It was derived based on data from manufacturing firms, but has since proven to be effective as well (with some modifications) in determining the risk a service firm will go bankrupt.

3: How should the results be judged?
It depends on:
1) Original Z-Score [For Public Manufacturer]
if the score is 3.0 or above --> bankruptcy is not likely.
if the score is 1.8 or less  --> bankruptcy is likely.
if the score is btw 1.8 and 30 --> it is the gray area.
Probability of bankruptcy within the above ranges are 95% of one year and 70% within two years. Obviously, a higher score is desirable.

2)Model A Z'-Score [For Private Manufacturer]
Model A of Altman's Z-Score is appropriate for a private anufacturing firm. Model A should not be applied to other companies. A score of 2.90 or above indicates that bankruptcy is not likely, but a score of 1.23 or below is a strong indicator that bankruptcy is likely. Probabilities of bankruptcy in the above ranges are 95% for one year and 70% within two years. Obviously, a higher score is desirable.

3) Model B Z'-Score [For Private General Firm]
Edward Altman developed this version of the Altman Z-Score to predict the likelihood of a privately owned non-manufacturing company going bankrupt within one or two years.
Model B is appropriate for a private general (non-manufacturing)
firm. Model B should not be applied to other companies. A score of
1.10 or lower indicates that bankruptcy is likely, while a score of
2.60 or above can be an indicator that bankruptcy is not likely. A
score between the two is the gray area. Probabilities of bankruptcy
in the above ranges are 95% for one year and 70% within two years.
Again, obviously, a higher score is desirable.

4: Z-Score formula

pls see attachment: picture_altman_z-score.gif

5: Books you can reference
John B. Caouette, Edward I. Altman, Paul Narayanan-Managing Credit Risk

You can find more on the <http://www.12manage.com/methods_altman_z-score.html> on the 12manage website.
Compare Z-Score to these other liquidity measurement ratios
Current Ratio:
<http://www.valuebasedmanagement.net/methods_current_ratio.html>
Quick Ratio:
<http://www.valuebasedmanagement.net/methods_quick_ratio.html>
Cash Ratio:
<http://www.valuebasedmanagement.net/methods_cash_ratio.html>
RAROC:
<http://www.valuebasedmanagement.net/methods_raroc.html>

reference to: http://www.valuebasedmanagement.net/methods_altman_z-score.html