Check your Z-Score: How's your Fiscal Fitness?
Routinely used by Stockbrokers trying to determine if a company is a good investment,
Bankers to determine loan risk, and internally, by anyone who wants to take close look at
his or her own company's financial health. Data
Needed: (Easily found in your company's financial statements.)
• Earnings before taxes
• Total assets
• Net Sales
• Market Value of Equity
• Total Liabilities
• Working Capital
• Retained Earnings
The worksheet will indicate: The short-term
potential for financial problems at your company.
The Expert: Edward I. Altman, Professor and
Vice-Director of New York University's Salomon Center, Leonard N. Stern School of
Business. Dr. Altman is known as the founding father of using statistical techniques to
predict company failure. He developed the Z-Score analysis almost 30 years ago, and is the
author of several books, including The Z-Score Bankruptcy Model: Past, Present, and
Future (New York: John Wiley & Sons, 1977), and Corporate Financial Distress and
Bankruptcy, 2nd edition (New York: John Wiley & Sons, 1993).
The Analysis: The Z-score was developed from an
analysis of 33 Chapter X-bankrupt manufacturing companies with average assets of $6.4
million, and, as controls, another 33 companies with assets between $1 million and $25
million.
Altman's Z-score calculates five ratios:
1. return on total assets,
2. sales to total assets,
3. equity to debt,
4. working capital to total assets, and
5. retained earnings to total assets.
These ratios are then multiplied by a predetermined weight
factor, and the results are added together. The final number--the Z-score--yields a number
between -4 and +8. Financially-sound companies show Z-scores above 2.99, while those
scoring below 1.81 are in fiscal danger, maybe even heading toward bankruptcy. Scores that
fall between these ends indicate potential trouble. In Altman's initial study of 33
bankrupt companies, Z-scores for 95 % of these companies pointed to trouble or imminent
bankruptcy.
Although the numbers that go into calculating the Z-score
(and a company's financial soundness) are sometimes influenced by external factors, it
provides a good quick analysis of where your company stands compared to the competition,
and a good tool for analyzing the ups and downs of your company's financial stability over
time. |
