The Altman Z-Score is an analytical representation created by Edward Altman in the 1960s which involves a combination of five distinctive financial ratios used for determining the odds of bankruptcy amongst companies. Most commonly, a lower score reflects higher odds of bankruptcy.
Formula for Z-Score
The Z-Score can be characterized as a linear combination of 4-5 common business ratios. These ratios are weighted by coefficients which are estimated by spotting a set of firms which had declared a bankruptcy. Thereafter, a matched sample of firms is collected for the surviving firms, with matching by industry and estimated assets. The formula for Z-Score and prediction of bankruptcy was given by Edward I. Altman in 1968. This formula for Altman Z-Score is helpful in calculating and predicting the probability that a company will go into bankruptcy within two years.
4-factor model of the Altman Z-score (for a private non-manufacturer):
Z-score = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4