Calculate Altman Z-Score Online – Instantly Assess a Company’s Financial Health

Altman Z-Score Calculator

Altman Z-Score Calculator

What is Altman Z Score

The Z-score, developed by Edward Altman in 1968, is a financial tool designed to predict the likelihood of a company going bankrupt. It helps assess a company's financial health, indicating how strong or solvent it is in both the short and long term.

The 5 Ratios (Components) of the Z-Score

To assess the financial health of a company, we can use five key financial ratios, each of which highlights a different aspect of performance. These ratios, when combined, provide a comprehensive view of the company’s stability and efficiency.

The Five Key Ratios:

1. X1 = Working Capital / Total Assets

2. X2 = Retained Earnings / Total Assets

3. X3 = EBIT / Total Assets

4. X4 = Market Value of Equity / Book Value of Total Liabilities

5. X5 = Sales / Total Assets

Each of these ratios is assigned a specific weight to reflect its relative importance in evaluating financial health:

X1 = 1.2

X2 = 1.4

X3 = 3.3

X4 = 0.6

X5 = 1.0

Now, let’s understand what each ratio tells us and why it has been given that particular weight.

• X1: Liquidity Indicator (Weight: 1.2)

This ratio shows the proportion of working capital to total assets. A higher ratio indicates greater liquidity, meaning the company is better positioned to meet its short-term obligations. It receives a moderate weight because liquidity is essential, but not the sole indicator of financial health.

• X2: Profitability & Financial Resilience (Weight: 1.4)

Retained earnings relative to total assets reflect how much profit the company has reinvested rather than distributed as dividends. Higher retained earnings indicate stronger internal funding and resilience in case of losses or emergencies. Hence, this ratio is slightly more important than liquidity.

• X3: Operating Efficiency (Weight: 3.3)

EBIT (Earnings Before Interest and Taxes) divided by total assets measures how efficiently a company generates profits from its assets. This is the most critical ratio, as it directly reflects operational performance and the company's ability to turn resources into profits.

• X4: Solvency or Leverage (Weight: 0.6)

This ratio compares the market value of a company’s equity to its total liabilities. It tells us whether the company could cover its liabilities by selling its equity in the market. A lower weight is assigned since market values can be volatile and influenced by external factors.

• X5: Asset Turnover Ratio (Weight: 1.0)

This ratio indicates how effectively the company uses its assets to generate sales. For instance, if a company has $1 million in assets, how much revenue can it generate from them? It’s a measure of productivity and operational efficiency.

In Summary:

The most critical ratio is X3, as it represents core profitability. The weightages reflect the priority as follows:

X3 > X2 > X1 > X5 > X4

Together, these ratios offer a balanced scorecard approach to evaluating a company's financial standing.

The Z-Score Formula and How to Interpret the Results

To evaluate a company’s financial health and potential risk of bankruptcy, we use the Altman Z-Score—a powerful tool that combines five key financial ratios into a single score.

The Z-Score Formula:

Z = (1.2X1) + (1.4X2) + (3.3X3) + (0.6X4) + (1.0X5)

Where:

X1 = Working Capital / Total Assets

X2 = Retained Earnings / Total Assets

X3 = EBIT / Total Assets

X4 = Market Value of Equity / Book Value of Total Liabilities

X5 = Sales / Total Assets

We’ve already discussed the meaning and importance of each of these ratios earlier. Now, let’s understand how the Z-score is interpreted.

Z-Score Interpretation:

• Z < 1.80 – Distress Zone:

The company is in financial distress. Investing in such a company is highly risky, as there is a significant chance of bankruptcy. It is advisable to avoid investing.

• Z = 1.81 to 2.99 – Grey Zone (Neutral Zone):

The financial health of the company is uncertain. There’s a moderate risk involved—it may improve or decline in the future. Investment in such companies should be done cautiously and with thorough analysis.

• Z ≥ 3.0 – Safe Zone:

The company appears financially strong and stable. It is considered a safe investment with low bankruptcy risk.

Altman Z-Score Calculation (A Step-by-Step Example)

Suppose you are evaluating a company and you know the following ratios:

X1 = 0.32

X2 = 0.22

X3 = 0.06

X4 = 0.62

X5 = 1.17

Now, let’s calculate the Z-score:

Z = (1.2X1) + (1.4X2) + (3.3X3) + (0.6X4) + (1.0X5)

Z = (1.2 × 0.32) + (1.4 × 0.22) + (3.3 × 0.06) + (0.6 × 0.62) + (1.0 × 1.17)

Z = 2.43

The company’s Z-score is 2.43, which falls into the Grey Zone. This suggests that the company is neither in immediate danger nor fully financially stable. As an investor, you should proceed with caution—conduct deeper research before making an investment decision. For the company, this score is a signal that steps should be taken to improve financial health and long-term stability. 

About the Author: Abhishek Lohar

B.Com Graduate and the Founder of Free Online Financial Calculator. I specialize in simplifying complex financial calculations and investment strategies. My mission is to ensure you can make confident financial decisions using our research-backed content and accurate calculators.

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Disclaimer: The information provided in this article is for educational purposes only and should not be considered financial advice. Please consult with a qualified professional before making any investment decisions.