Altman Z-Score
The Altman Z-score is a statistical tool used to assess the financial health of a company. It is based on the company’s current assets, current liabilities, quick assets, and retained earnings.
Formula:
Z-score = 0.5232 + 0.1999*X - 1.2824*Y
where:
- X is the working capital/current liabilities ratio
- Y is the retained earnings/assets ratio
Interpretation:
- A Z-score above 3 is considered overvalued and at high risk of bankruptcy.
- A Z-score between -1 and 3 is considered to be at normal risk.
- A Z-score below -1 is considered undervalued and at low risk of bankruptcy.
Uses:
- Investors use the Z-score to assess the financial health of a company.
- Companies use the Z-score to monitor their own financial health and to compare themselves to competitors.
- Creditors use the Z-score to assess the risk of lending to a company.
Limitations:
- The Z-score does not consider industry differences.
- The Z-score does not consider company size.
- The Z-score does not consider other factors that may influence financial health, such as economic conditions and industry trends.
Additional Notes:
- The Altman Z-score is a simple metric and should not be used as the sole basis for making investment decisions.
- It is important to consider other factors, such as the company’s industry, size, and financial performance.
- The Z-score is a powerful tool for analyzing company financial health, but it is not a perfect one.
FAQs
What is a good Altman Z-Score?
A good Altman Z-Score is typically above 2.99, indicating that the company is in a safe financial zone and has a low risk of bankruptcy.
What does an Altman’s Z-Score of 3.5 indicate?
An Altman Z-Score of 3.5 suggests a very strong financial position, with a low risk of bankruptcy in the near future.
What is a 2.7 Altman Z-Score?
A Z-Score of 2.7 falls in the “gray area,” meaning the company is not at immediate risk of bankruptcy but is also not completely safe. Caution is advised.
Why do we use the Altman Z-Score?
The Altman Z-Score is used to assess a company’s likelihood of bankruptcy by analyzing financial ratios. It helps investors and analysts evaluate financial health.
Is a high or low Z-Score better?
A higher Z-Score is better, as it indicates a lower risk of bankruptcy. Scores below 1.8 suggest financial distress, while scores above 2.99 are considered safe.
