Scribd
Upload
122 views20 pages

Guidance On Z-Score Analysis

The document discusses the Z-score model developed by Edward Altman for predicting corporate bankruptcy. The Z-score uses multiple discriminant analysis and 5 key financial ratios to provide a measure of the financial health of a company. A higher Z-score indicates a lower risk of bankruptcy, with scores above 2.99 considered the "safe zone" and below 1.81 in the "distress zone". The model was found to correctly classify bankrupt companies 95% of the time and non-bankrupt companies around 80% of the time. Later versions of the Z-score modified the ratios used and thresholds for different types of companies and industries.

Uploaded by

Khalil Akram
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
122 views20 pages

Guidance On Z-Score Analysis

The document discusses the Z-score model developed by Edward Altman for predicting corporate bankruptcy. The Z-score uses multiple discriminant analysis and 5 key financial ratios to provide a measure of the financial health of a company. A higher Z-score indicates a lower risk of bankruptcy, with scores above 2.99 considered the "safe zone" and below 1.81 in the "distress zone". The model was found to correctly classify bankrupt companies 95% of the time and non-bankrupt companies around 80% of the time. Later versions of the Z-score modified the ratios used and thresholds for different types of companies and industries.

Uploaded by

Khalil Akram
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
You are on page 1/ 20

A condition where a company cannot meet or

has difficulty in paying off its financial


obligations to its creditors and equity holders.
 Edward I. Altman is a Professor of Finance at New York
University`s Stern School of Business.

 Dr. Altman has an international reputation as an expert on


corporate bankruptcy, high yield bonds, distressed debt and
credit risk analysis.

 He is best known for the development of the Z-Score for


predicting bankruptcy published in 1968.
Z Score is a general measure of corporate financial
health.
The purpose of this analysis is to find the possibility of
bankruptcy in various companies.
 Sample size: 66 corporations

33 bankrupt (asset size:$1 million to $26 million)

33 with strong financial health (asset size: $5


million to $130 million)

 22 common financial ratios were selected and analyzed


 Financial data were derived from Moody’s Industrial
Manuals and also from selected annual reports
 Multiple Discriminant Analysis was applied (many
characteristics can be combined into a single score).
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

 1.2, 1.4, 3.3, 0.6, and 1 represents Discriminant


weights or coefficients assigned to the ratios

 X1-X5 are the five ratios screened.


X1------ Working Capital/Total Assets(WC/TA)

Measure of the net liquid assets of the firm relative


to the total capitalization

Firms on the road to bankruptcy would be expected


to have less liquidity.
X2---Retained Earnings/Total Assets (RE/TA)

It measures the leverage of a firm. Those firms with high


RE, relative to TA, have financed their assets through
retention of profits and have not utilized as much debt.

Companies with high RE/TA suggest a history of


profitability and the ability to stand up to a bad year of
losses.

The age of a firm is implicitly considered in this ratio.


X3---Earnings Before Interest and
Taxes/Total Assets (EBIT/TA)

Measure of the true productivity of the firm’s assets,


independent of any tax or leverage factors.
A firm’s ultimate existence is based on the earning
power of its assets
Insolvency occurs when the total liabilities exceed a fair
valuation of the firm’s assets with value determined
by the earning power of the assets.
X4---- Market Value of Equity/Book Value
of Total Liabilities (MVE/TL)

The book value of liabilities is the total value of liabilities


both long term and current
It gives technical analysis perspective to the analysis

It determines the proportion by which company’s assets are


financed through equity and debts

Shows how much the firm’s assets can decline in value


(measured by market value of equity plus debt) before the
liabilities exceed the assets and the firm becomes
insolvent.
X5--------- Sales/Total Assets (S/TA)

Illustrates the sales generating ability of the firm’s


assets.
Also known as assets turnover
Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

Z > 2.99 “Safe” Zone

1.81 < Z < 2.99 “Grey” Zone

Z < 1.81 “Distress” Zone


Validity of Z-Score Analysis

To test the model, Altman calculated the Z Scores for new


groups of bankrupt and non-bankrupt firms.

 95% of the bankrupt firms were correctly classified as


bankrupt.

 Roughly 80% of the sick, non-bankrupt firms were correctly


classified as non-bankrupt.

 Of the misclassified non-bankrupt firms, the scores of nearly


three fourths of these fell into the grey area.
 In general, Z Score Analysis gives 72-80% correct results.
What about market value of equity
for private companies???

X4???????

Market Value of Equity/Book Value of Total


Liabilities (MVE/TL)
Z Score Analysis for Manufacturing Concerns

Z Score Analysis for Private Companies

Z Score Analysis for Non-Manufacturer Industrials &


Emerging Market Credits
Z = 0.717X1 + 0.847X2 + 3.107X3 +0.42X4 +
0.998X5

X4----Book Value of Equity / Total Liabilities

Book Value of Equity is net worth

Z > 2.9 “Safe” Zone


1.23 < Z < 2. 9 “Grey” Zone
Z < 1.23 “Distress” Zone
Z = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4

Z > 2.6 -“Safe” Zone


1.1 < Z < 2. 6 “Grey” Zone
Z < 1.1 “Distress” Zone
 Window dressing in financial statements

 Z scores application on regular basis

 A low score indicates that detailed analysis is required

 Z Score model is a tool that complement your other


analytical tools

You might also like

pFad - Phonifier reborn

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.

Note: This service is not intended for secure transactions such as banking, social media, email, or purchasing. Use at your own risk. We assume no liability whatsoever for broken pages.


Alternative Proxies:

Alternative Proxy

pFad Proxy

pFad v3 Proxy

pFad v4 Proxy