# Altman Z-Score Calculator

*“The Effect of Financial Ratio (Altman Z-Score) on Financial Distress Prediction in Manufacturing Sector in Indonesia 2016-2018“*Atlantis Press (January 2020)

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`

,

where,

`NWC`

- Net working capital; and`TA`

- Total assets.

The

`NWC`

can 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**

The

`RE/TA ratio`

measures the accumulated profitability of a company and you can calculate it using the formula below:

`RE/TA ratio = RE / TA`

,

where,

`RE`

- Retained earnings.

The

`RE`

can 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 ratio`

and it measures a company's profitability. Its formula is:

`EBIT/TA ratio = EBIT / TA`

,

where,

`EBIT`

- Earnings before interests and taxes.

For our example:

`EBIT/TA ratio = $4,000,000 / $50,000,000 = 0.08`

.

**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`

,

where,

`MVA`

- Market value of equity; and`TL`

- Total liabilities.

The formula for

`MVE`

is:

`MVE = share price * number of shares outstanding`

In our example, Company Alpha's

`MVE/TL ratio`

is:

`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`

.

**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`

The

`Altman Z-Score`

for 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.

## FAQ

### 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**.

### 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.