A statistical model, devised in the 1960s by Edward Altman (of New York University), which is used to predict the probability of a company failure or bankruptcy within the next two years, based on multiple discriminatory analysis. The higher the Z score, the lower that probability. Typically, a company’s Z score is a positive function of five balance-sheet and profit-and-loss-account measures:
- (net working capital)/ (total assets)
- (retained earnings)/ (total assets)
- (EBIT)/ (total assets)
- (market value of common and preferred shares)/ (book value of debt)
- (sales)/ (total assets)
These factors are then differently weighted to reflect their relative magnitude before being combined into a single figure, the Z score. A score above three implies that bankruptcy is unlikely; a score below 1.8 indicates that bankruptcy is possible.
The Z-score is also called Altman Z-score or “Zeta“.
