Altman Z Score
The Altman Z Score is starting point for financial condition. The formula is a function of liquidity, balance sheet strength and earnings power.
There is much debate whether the Altman Z score is useless, outdated or whether it even works but it serves a very simple purpose if you dont make it do more then it was intended to do.
- A = Working Capital / Total Assets
- B = Retained Earnings / Total Assets
- C = EBITDA / Total Assets
- D = Market Value of Equity / Total Liabilities
- E = Net Sales / Total Sales
What does the Altman Z score mean?
- Z <= 1.8 – Bankruptcy probable
- Z is 1.8 to 2.7 = Within 2 years bankruptcy probable
- Z is 2.7 to 3.0 = Bankruptcy safe in the near term
- Z >= 3.0 – Bankruptcy Safe
Things that create some issues for the Altman Z
The formula was originally founded for operating industrial companies and maybe regulated utilities show up as having high bankruptcy risk.
Negative Working Capital isn’t always bad. Some companies have so much leverage over their suppliers that they can extract very favorable payment terms and current liabilities can outweigh current assets. A restaurant is paid in cash, but their suppliers often give them net 30 on payables and the inventory (food) turns very very quickly.
High Positive Working Capital isn’t always good. If a company has too much inventory or they are not investing their excess cash.
Financials are also not a good use of the Altman Z score.
Companies undergoing turnarounds are not ideal candidates, nor are startups or early growth companies.