What is the Altman ZScore?
The Altman ZScore, designed by NYU Professor Edward Altman, is a model used to predict the nearterm likelihood of companies falling into bankruptcy or insolvency.
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How to Calculate the Altman ZScore
Originally developed to evaluate the probability of bankruptcy within the manufacturing industry, the Altman zscore utilizes a weighting system of various financial ratios that each measure a specific financial attribute.
The purpose of the zscore model is to measure a company’s financial health and quantify the probability of the company filing for bankruptcy or needing restructuring in the near future, i.e. within two years.
Often used as part of credit analysis – i.e. by lenders or distressed investors protecting their downside risk – the combined financial ratios analyze the company’s core operational strength, liquidity position, solvency, profit margins, and leverage and combine them into an overall score.
The five components of the zscore calculation are described below.
 X1 = Working Capital ÷ Total Assets

 The working capital to total assets ratio measures the company’s shortterm liquidity.

 X2 = Retained Earnings ÷ Total Assets

 The retained earnings to total assets ratio measure a company’s reliance on debt financing to fund operations, so a higher ratio indicates the company can fund its operations using its earnings rather than borrowings.

 X3 = EBIT ÷ Total Assets

 The operating income to total assets ratio measures a company’s ability to generate operating profits using its assets, meaning that a higher ratio indicates greater profits and assetutilization efficiency.

 X4 = Market Capitalization ÷ Total Liabilities

 The market cap to total liabilities ratio measures the potential downside in the market value of equity given the risk of insolvency. Hence, a low market cap relative to its liabilities reflects weak market sentiment regarding the company’s outlook.

 X5 = Sales ÷ Total Assets

 The sales to total assets ratio measures the sales generated compared to a company’s asset base. Thus, a higher percentage means more efficiency in producing revenue (and higher profitability due to reduced reliance on reinvestments).

As a side note, it is recommended for the “Total Assets” metric to exclude any intangible assets.
Altman ZScore Formula
Putting together the prior section, the equation for calculating the zscore multiplies each ratio by a weighted metric, and the sum represents the zscore of the company.
The original zscore formula intended for public manufacturing companies is shown below:
Altman ZScore Formula
 Altman ZScore = (1.2 × X1) + (1.4 × X2) + (3.3 × X3) + (0.6 × X4) + (0.99 × X5)
The formula above is the most common variation of the Altman zscore, although each model consists of different variables and weighing systems that affect the score.
As such, it is crucial to pick the most suitable model for the company being analyzed (and also to understand the limitations of the model).
For reference, below are the formulas for some of the other more common model variations:
 Private Manufacturing Companies → ZScore = 0.717 × X1 + 0.847 × X2 + 3.107 × X3 + 0.42 × X4 + 0.998 × X5
 Private General NonManufacturing Services Companies → ZScore = 6.56 × X1 + 3.26 × X2 + 6.72 × X3 + 1.05 × X4
 Emerging Market Companies → ZScore = 3.25 + 6.56 × X1 + 3.26 × X2 + 6.72 × X3 + 1.05 × X4
Interpreting the ZScore System
The Altman zscore quantifies the financial stability of a company to predict how likely a company will become insolvent.
Typically, a lower Z score value indicates a higher risk of bankruptcy and vice visa.
While a high zscore does not necessarily imply sound financial health and longterm viability, a low zscore is a potential red flag suggesting the need to pry deeper into a company’s fundamentals.
For public manufacturing companies, the following rules serve as general benchmarks:
ZScore  Interpretation 

> 2.99  Safe Zone – Low Likelihood of Bankruptcy 
1.81 to 2.99  Grey Zone – Moderate Risk of Bankruptcy 
< 1.81  Distress Zone – High Likelihood of Bankruptcy 
For private nonmanufacturing companies, the benchmarks are as follows:
ZScore  Interpretation 

> 2.60  Safe Zone – Low Likelihood of Bankruptcy 
1.10 to 2.6  Grey Zone – Moderate Risk of Bankruptcy 
< 1.10  Distress Zone – High Likelihood of Bankruptcy 
Limitations to the ZScore
One of the main drawbacks of the zscore model is how abnormalities – that are not necessarily negative indicators of a company’s financial state – can result in a lower zscore.
For instance, companies operating in the restaurant industry often exhibit a negative working capital cycle, i.e. in such cases, negative working capital could signify strong cash flow management, not potential insolvency.
Additionally, earlystage companies that are growing rapidly yet are unprofitable are not suited for the model.
Therefore, the zscore model – as is the case with all models and theories – must only be relied upon once deemed appropriate to the situation and serve as a single tool among many to evaluate a company’s likelihood of potential bankruptcy.
Altman ZScore Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Altman ZScore Example Calculation
Suppose a public manufacturing company is at risk of insolvency following several periods of underperformance, particularly in terms of profitability.
Using the original zscore model, we’ll estimate the chance of bankruptcy of our hypothetical company.
The following assumptions will be used for our modeling exercise.
 Current Assets = $60 million
 Current Liabilities = $40 million
 Fixed Assets = $100 million
 Net Income = $10 million
 Dividends = $2 million
 Sales = $60 million
 COGS and SG&A = $40 million
 P/E Multiple = 8.0x
 Total Liabilities = $120 million
Given those initial assumptions, our next step is calculating the remaining inputs.
 Working Capital = $60 million – $40 million = $20 million
 Total Assets = $60 million + $100 million = $160 million
 Retained Earnings = $10 million – $2 million = $8 million
 Operating Income (EBIT) = $60 million – $40 million = $20 million
 Market Capitalization = 8.0x × 10 million = $80 million
We can observe that the excess current assets barely cover the current liabilities.
As a manufacturing company, the company’s operations rely on significant purchases of fixed assets (PP&E) – i.e. capital expenditures – as confirmed by the $100 million in fixed assets.
Moreover, the company’s net margin is approximately 17%, with a dividend payout ratio of 20%. If necessary, those dividend issuances would need to be halted soon.
While the operating margin and net margin are not necessarily poor, especially for the manufacturing sector, the more concerning red flag is the low P/E multiple (and market capitalization) – which suggests the market is not optimistic about the company’s future growth and profitability.
Considering the low net income, the P/E multiple here could be misleading high, so the 8.0x – despite being a normal valuation multiple in most industries – should be perceived negatively.
The inputs for our zscore calculation are the following:
 X1 = Working Capital ÷ Total Asset = 0.13
 X2 = Retained Earnings ÷ Total Assets = 0.05
 X3 = EBIT ÷ Total Assets = 0.13
 X4 = Market Capitalization ÷ Total Liabilities = 0.67
 X5 = Sales ÷ Total Assets = 0.38
We then plug the inputs into our zscore formula:
 ZScore = (1.20 × 0.13) + (1.40 × 0.05) + (3.30 × 0.13) + (0.60 × 0.67) + (0.99 × 0.38) ZScore = 1.40
Since the zscore of 1.40 is below 1.81, our company is in the “Distress Zone,” where the risk of nearterm insolvency is high.