Altman Z-Score

Altman Z-Score

Overview

Altman Z-Score is a linear discriminant model predicting bankruptcy probability from five financial ratios. Z = 1.2X₁ + 1.4X₂ + 3.3X₃ + 0.6X₄ + 1.0X₅. Zones: Z > 2.99 (safe), 1.81-2.99 (grey), Z < 1.81 (distress). Originally for public manufacturing firms; variants exist for private and non-manufacturing.

When to Use

Trigger conditions:

• Screening companies for bankruptcy risk
• Quick credit assessment using publicly available financials
• Monitoring portfolio companies for financial distress signals

When NOT to use:

• For financial institutions (banks, insurers) — different capital structures
• When detailed credit scoring is needed (use logistic regression credit models)

Algorithm

IRON LAW: Z-Score Was Calibrated for PUBLIC MANUFACTURING Firms
Applying the original formula to private firms, service companies, or
emerging markets WITHOUT using the appropriate variant produces
misleading results. Use Z'-Score for private firms, Z''-Score for
non-manufacturing and emerging markets.

Phase 1: Input Validation

Extract from financial statements: working capital, retained earnings, EBIT, market cap (or book equity for private), total assets, total liabilities, sales. Gate: All five inputs available, from same reporting period.

Phase 1.5: Variant Selection (MANDATORY)

Before touching any formula, pick the right variant — this is the single most common mistake when applying Altman Z.