Altman Z-Score

The Altman Z-Score is a statistical measure used to predict the probability of a company going bankrupt within two years based on financial ratios.

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🔎 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 
- B = Retained Earnings ÷ Total Assets → Measures profitability over time 
- C = EBIT ÷ Total Assets → Measures operating profitability 
- D = Market Cap ÷ Total Liabilities → Measures market perception 
- E = Sales ÷ Total Assets → Measures asset turnover 

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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 

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📊 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 

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📌 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. 

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✅ 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

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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. 

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