Altman Z-Score, usually the designation Z factor or Z-score is used. It is a term that identifies a model for the valuation of enterprise crisis. It is one of the models of multiple discriminant analysis. The model was built in 1968 by Edward Altman, Professor of Finance at New York University School of Business. Edward Altman chose at first 22 indicators divided into groups of liquidity, profitability, indebtedness, solvency and asset management. He tested them always on two groups of companies, when one of the groups was bankrupt company. From the original 22 indicators were finally selected the 5 most important indicators that predict bankruptcy the best. The result was discrimination function expressed by Z factor.
Z = 3.3 × EBIT / Assets + 1 × Sales / Assets + 0.6 Equity Market Value / Debt Book Value + 1.4 × Retained Earnings / Assets + 1.2 × Net Working Capital / Assets
Rules for evaluation of Z factor:
- 3.00 < Z - Safe Zone - companies with a high probability of survival
- 1.80 < Z < 2.99 - Grey Zone - it is difficult to determine the result
- Z < 1.79 - Distress Zone - Companies threatened by bankruptcy
This is the original Altman tested according to joint stock companies in the U.S.. Predicative ability of the model may be in other countries weakened.
Use of the Altman Z-Score in practice: Testing with Altman Z Factor predicts relatively reliably the bankruptcies of companies with two-year advance. The statistical reliability is lower in the long period. Improved Altman models are used by banks and large industrial companies to assess the financial health and overall financial situation.
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