Application of Altman Z Score / Bankruptcy Score Formula

 Application of Altman Z Score / Bankruptcy Score Formula

The formula is used to predict corporate defaults or bankruptcy or in academic language, financial distress position of companies.

The formula is based on discriminant analysis technique in statistical analysis.

The formula uses multiple variables from income statement and balance sheet of companies.

What’s the formula?

Formula =

Altman Z-Score = 1.2*T1 + 1.4*T2 + 3.3*T3 + 0.6*T4 + 1.0*T5

Here are the key definitions from the above formula:

T1 = Working Capital / Total Assets

This ratio measures liquid assets. The companies in trouble will usually experience shrinking liquidity.

T2 = Retained Earnings / Total Assets

This ratio calculates the overall profitability of the company. Dwindling profitability is a warning sign.

T3 = Earnings before Interest and Taxes / Total Assets

This ratio shows how productive a company is in generating earnings, relative to its size.

T4 = Market Capitalization / Total Liabilities

This ratio suggests how far the company’s assets can decline before it becomes technically insolvent (i.e., its liabilities become higher than its assets).

T5 = Sales / Total Assets

This is the asset turnover ratio and is a measure of how effectively the firm uses its assets to generate sales