Altman Z-Score Calculator
We designed this Altman Z-Score calculator to help you easily calculate the Altman Z-Score. Altman Z-Score is one of the most famous bankruptcy prediction models. It is widely used to quantify the probability of a company going default.
We prepare this article to help you understand what is Altman Z-Score and how to calculate it using the Altman Z-Score formula. We will also help you understand what is a good Altman Z-Score. However, before we talk about how to interpret the Altman Z-Score, let's first make sure we understand the definition of this metric.
What is Altman Z-Score?
Altman Z-Score is a bankruptcy prediction model designed by Professor Edward Altman in 1968 to quantify the probability of a company going default. The Altman Z-Score is the product of the discriminant analysis performed by Professor Altman.
Unlike other bankruptcy predicting methods, the Altman Z-Score can incorporate various ratios into a single equation. This allows user to avoid over-relying on a particular financial ratio to assess the credit risks of a company.
The following example will help us to understand the Altman Z-Score calculation precisely .
How to calculate Altman Z-Score? The Altman Z-Score formula
Let's take Company Alpha as an example to help us understand the concept of the Altman Z-Score in our Altman Z-Score calculator. Company Alpha reports the following information:
- Number of shares outstanding: 1,000,000;
- Share price: $20;
- Dividend per share: $0.50;
- Sales: $10,000,000;
- EBIT: $4,000,000;
- Net income: $1,000,000;
- Accounts receivable: $200,000;
- Accounts payable: $100,000;
- Inventory: $300,000;
- Total assets: $50,000,000; and
- Total liabilities: $20,000,000.
We need to calculate 5 ratios to compute the Altman Z-Score. The whole process takes 6 steps:
Calculate net working capital / total assets ratio
This ratio measures the short-term liquidity risk of a company and is calculated as:
NWC/TA ratio = NWC / TA,
NWC- Net working capital; and
TA- Total assets.
NWCcan be calculated using the formula below:
NWC = accounts receivable + inventory - accounts payable
For Company Alpha:
NWC/TA ratio = ($200,000 + $300,000 - $100,000) / $50,000,000 = $400,000 / $15,000,000 = 0.008.
Calculate retained earnings / total assets ratio
RE/TA ratiomeasures the accumulated profitability of a company and you can calculate it using the formula below:
RE/TA ratio = RE / TA,
RE- Retained earnings.
REcan be calculated as:
RE = net income - dividend per share * number of shares outstanding
For Company Alpha:
RE/TA ratio = ($1,000,000 - $0.50 * 1,000,000) / $50,000,000 = $500,000 / $15,000,000 = 0.01.
Calculate EBIT / total assets ratio
The next ratio to calculate is the
EBIT/TA ratioand it measures a company's profitability. Its formula is:
EBIT/TA ratio = EBIT / TA,
EBIT- Earnings before interests and taxes.
For our example:
EBIT/TA ratio = $4,000,000 / $50,000,000 = 0.08. You can also use our ebit calculator to calculate the EBIT.
Calculate market value of equity / total liabilities ratio
This ratio tells you about the company's leverage. It is calculated as:
MVE/TL ratio = MVE / TL,
MVA- Market value of equity; and
TL- Total liabilities.
The formula for
MVE = share price * number of shares outstanding
In our example, Company Alpha's
MVE/TL = ($20 * 1,000,000) / $20,000,000 = $20,000,000 / $20,000,000 = 1.0.
Calculate sales / total assets ratio
The last ratio to calculate is the
sales/TA ratio, which measures a company's ability to generate revenue. The formula for this ratio is:
sales/TA ratio = sales / TA
For our example:
sales/TA ratio = $10,000,000 / $50,000,000 = 0.2.
You can also check out our total asset turnover calculator.
Compute the Altman Z-Score
Now that we have all the ratios calculated, it's time for us to compute the Altman Z-Score. The metric can be calculated using this formula:
Altman Z-Score = 1.2 * NWC/TA + 1.4 * RE/TA + 3.3 * EBIT/TA + 0.6 * MVE/TL + 1.0 * sales/TA
Altman Z-Scorefor Company Alpha is:
Altman Z-Score = 1.2 * 0.008 + 1.4 * 0.01 + 3.3 * 0.08 + 0.6 * 1 + 1.0 * 0.2 = 1.0876.
How to interpret the Altman Z-Score?
In general, when it comes to what is a good Altman Z-Score, the higher the score, the better. The higher the Altman Z-Score, the lower the probability of a company defaulting.
To put the topic into more context, let's quantify the Altman Z-Score. The following are the standard method to interpret the Altman Z-Score:
- If the Altman Z-Score is lower than 1.81, it means there is a high probability of the company defaulting;
- If the Altman Z-Score is higher than 3, it means there is a the probability of the company defaulting is low; and
- If the Altman Z-Score is between 1.81 and 3, it means there is no clear indicator, and further analysis is needed to be done to draw a conclusion
As a general rule of investing, it is usually dangerous to base your decision on merely one metric. Hence, always confirm your conclusion by looking at other similar metrics.
What is EBIT?
EBIT stands for earnings before interests and taxes. In short:
EBIT = net income + interest expenses + taxes.
It is usually interpreted as the operating income.
How is the Altman Z-Score equation formed?
Unlike the usual credit analysis models, which are derived qualitatively, the Altman Z-Score is a quantitate model. The Altman Z-Score formula was designed by Professor Edward Altman and its coefficients are determined using discriminant analysis.³
What is a good Altman Z-Score?
As a general rule of thumb, a Altman Z-Score that is higher than 3 signifies a healthy company. On the other hand, a Altman Z-Score lower than 1.81 means that the probability of the company defaulting is significant.
Can Altman Z-Score be negative?
Mathematically, yes, since EBIT and net working capital can be negative. However, this is quite rare as the sales and market value of equity figures are usually a lot larger than these figures.