The Altman Z-Score Calculator is a financial tool used to measure a company’s financial health. It helps in determining the probability that a company will go bankrupt within two years. That algorithm compares the company’s current assets, liabilities, and net worth to those of similar companies.
This can be an excellent metric for predicting the success or failure of a business. It is used for a variety of purposes in different fields, including finance, economics, and statistics.
To help you effortlessly calculate this score, we’ve created the Altman Z-Score calculator and shared it here for your convenience. Here, you can also get a better understanding of how to use the formula for Altman Z-Score, what’s a good/bad score, how to interpret it, and much more.
What’s Altman Z-Score?
As a matter of fact, it is a bankruptcy prediction model. It dates back to 1968 when a famous professor of finance Edward I. Altman designed it to determine the chances of companies going default. It’s the outcome of discriminant analysis.
The Z-score is a statistical measure of how many standard deviations an observation or data point is from the mean. What sets the Altman Z-Score apart from other methods for bankruptcy forecasting is that a single equation can consist of a variety of ratios. Therefore, you will not rely on a single financial ratio when assessing a company’s credit risk.
Essentially, the z-score involves taking the company’s credit rating and dividing it by its debt rating. Do you want to find out how exactly the calculation of the Altman Z-Score is performed by computers? Read on to learn!
The Altman Z-Score formula: How Altman Z-Score Is Calculated?
Now that you know more about the Altman Z-Score, let’s see what the Z Score formula looks like. To calculate Altman Z-Score, you need to use this complex formula:
Z Score = 1.2*(working capital / total assets) + 1.4*(retained earnings / total assets) + 3.3*(earnings before interest and tax / total assets) + 0.6*(market value of equity / total liabilities) + 1.0*(net sales / total assets)
This is the Original Public Firms formula for Altman Z-Score. As you can see, there are a lot of elements to take into account, including the market value of equity, working capital, net sales, total assets, as well as retained earnings, earnings before interest and taxes.
Do you want to try it out? Okay, use the following figures:
- Working Capital: $10,000
- Retained Earnings: $2,000
- Earnings before Interest and Taxes: $3,000
- Market value of Equity: $2,000
- Net Sales: $50,000
- Total Assets: $20,000
When you put all of this in the calculator, the Z-Score will be 3.795. This is a good score.
There’s another way to calculate the Altman Z-Score. It involves computing 5 ratios. For this method, you will need the following inputs:
- Total liabilities
- Total assets
- Inventory
- Accounts payable
- Accounts receivable
- Net income
- Sales
- Dividend per share
- Share price
- Number of shares outstanding
- EBIT (interest expenses + net income + taxes)
We are going to divide the process into 6 sections to make it easier for you to figure out the concept of this method.
Step 1: Net working capital (NWC) / total assets (TA) ratio
This ratio is intended to estimate a company’s short-term liquidity risk. Here’s how to calculate it:
Ratio 1 = NWC / TA
- TA- Total assets
- NWC – Net working capital
To calculate net working capital, use this simple formula:
NWC = inventory + accounts receivable – accounts payable
Step 2: Retained earnings (RE) / total assets (TA) ratio
The next thing you need to calculate is the RE/TA ratio. It is meant to measure a company’s accumulated profitability. Here’s the formula to use:
Ratio 2 = RE / TA
- TA – Total assets
- RE – Retained earnings; RE = net income – number of shares outstanding * dividend per share
Step 3: EBIT / TA (total assets) ratio
Now it is time to compute the EBIT / TA ratio. This figure can help you measure the profitability of a company. The formula is as follows:
Ratio 3 = EBIT / TA
In this formula, EBIT refers to earnings before interests and taxes. EBIT is calculated by adding interest expenses to net income and taxes.
Step 4: Market value of equity (MVE) / total liabilities (TL) ratio
If you want to determine the leverage of a company, then you will need to calculate this ratio using the following formula:
Ratio 4 = MVE / TL
- TL – Total liabilities
- MVA – Market value of equity; MVE = number of shares outstanding * share price
Step 5: Calculate sales / TA (total assets) ratio
This is the last ratio that should be calculated. It is used to find out whether a company is able to generate revenue. To calculate it, use this formula:
Ratio 5 = Sales / TA
Step 6: Computing the Altman Z-Score
Have you calculated all the ratios? Great! Now you are ready to calculate the Altman Z-Score as well. To compute this metric, use the formula:
Z Score = 1.4 * RE/TA + 1.2 * NWC/TA + 0.6 * MVE/TL + 3.3 * EBIT/TA + Sales/TA
FAQs
How the Altman Z-Score Is Interpreted?
The higher the Z-score, the better the company’s financial status (the lower likelihood of defaulting). Let’s be more specific. When interpreting the Altman Z-Score, you need to use this method:
- <1.81 – the chances of the company defaulting are high
- From 1.81 to 3 – there’s no clear indicator, which raises the need for further analysis
- > 3 – there is a low likelihood of the company defaulting
So, what’s a good Z-Score? Anything above 3 is considered to be good. It indicates that the company is healthy in terms of finance.
Can It Be Negative?
In mathematical terms, yes. Just like net working capital (NWC), EBIT can also be negative. That’s quite rare though. In reality, the market value of a company’s equity and sales are large compared to these figures.