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Altman Z-ScoreThe Altman Z-Score is a statistical measure used to predict the probability of a company going bankrupt within two years based on financial ratios.
🔎 Formula: Z = (1.2 × A) + (1.4 × B) + (3.3 × C) + (0.6 × D) + (1.0 × E) Where: -
A = Working Capital ÷ Total Assets → Measures liquidity
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B = Retained Earnings ÷ Total Assets → Measures profitability over time
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C = EBIT ÷ Total Assets → Measures operating profitability
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D = Market Cap ÷ Total Liabilities → Measures market perception
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E = Sales ÷ Total Assets → Measures asset turnover
Altman Z-Score Zones: - **Distress Zone** → Z < 1.8 → High risk of bankruptcy
- **Grey Zone** → 1.8 ≤ Z ≤ 3.0 → Possible financial trouble
- **Safe Zone** → Z > 3.0 → Low risk of bankruptcy
📊 Example Calculation (ProfitCo): | Metric | Value | Formula | Result |
| Working Capital | $2,000 | Working Capital ÷ Total Assets | 20% |
| Retained Earnings | $3,000 | Retained Earnings ÷ Total Assets | 30% |
| EBIT | $2,500 | EBIT ÷ Total Assets | 25% |
| Market Cap | $12,000 | Market Cap ÷ Total Liabilities | 2.4 |
| Sales | $20,000 | Sales ÷ Total Assets | 200% |
Altman Z-Score Calculation: Z = (1.2 × 20%) + (1.4 × 30%) + (3.3 × 25%) + (0.6 × 2.4) + (1.0 × 200%) → Z = (1.2 × 0.20) + (1.4 × 0.30) + (3.3 × 0.25) + (0.6 × 2.4) + (1.0 × 2.0)
→ Z = 0.24 + 0.42 + 0.825 + 1.44 + 2.0
→ Z = **4.925**
✅ Result: → Z = **4.925** → Safe Zone → Low risk of bankruptcy
📌 Interpretation of ProfitCo's Z-Score: - Z = **4.925** → Safe Zone → ProfitCo is financially strong with low bankruptcy risk.
- High EBIT and strong sales/assets ratio reflect strong operating performance.
- Market Cap/Total Liabilities ratio of **2.4** indicates good market confidence.
✅ Summary Example (Cable Factory): | Metric | Example | Value | Contribution |
| Working Capital ÷ Total Assets | 2,000 ÷ 10,000 | 0.20 | 0.24 |
| Retained Earnings ÷ Total Assets | 3,000 ÷ 10,000 | 0.30 | 0.42 |
| EBIT ÷ Total Assets | 2,500 ÷ 10,000 | 0.25 | 0.825 |
| Market Cap ÷ Total Liabilities | 12,000 ÷ 5,000 | 2.4 | 1.44 |
| Sales ÷ Total Assets | 20,000 ÷ 10,000 | 2.0 | 2.0 |
| Altman Z-Score | 4.925 | Safe Zone | Low Bankruptcy Risk |
Practical Insights: - A Z-Score **below 1.8** indicates a high probability of financial distress → Immediate action needed.
- A Z-Score **between 1.8 and 3.0** indicates moderate risk → Focus on improving profitability and cash flow.
- A Z-Score **above 3.0** indicates financial stability → Maintain current strategy and focus on growth.
How to Improve Z-Score: ✔ Increase Working Capital → Improve cash flow management.
✔ Boost EBIT → Increase operational efficiency.
✔ Strengthen Market Cap → Increase investor confidence.
✔ Improve Asset Turnover → Increase sales or reduce asset base.
✔ Retain Earnings → Avoid unnecessary dividend payouts.