How Does Altman 's Z Score Formula Work And How Can We Make Predictions Using This Formula?

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Altman’s Z-score Formula Mary Carnahan QN320 – Essential Statistical Thinking July 27, 2016 Introduction How does Altman’s z-score formula work and how can we make predictions using this formula. I’m going to look for an article online in which someone has made a prediction using the formula. Also, I’m going to explain how the z-score formula is used within the business and financial world. How does this formula ultimately help businesses and financial institutions make key decisions? Who is Behind the Altman’s Z-score Formula? The Altman Z-score is a famous formula for measuring a company’s financial worthiness devised by Edward Altman. “Edward Altman: When I was a graduate student at UCLA in the mid-1960s, one of…show more content…
If he had been on the scene two years later, someone else would have already done the work. Altman combined a number of financial indicators with a technique for statistical classification known as discriminant analysis to predict bankruptcy. That was written in 1967, published in 1968, [and] known as the Z-score model or the Altman Z-score. And this model originally was built and still is mainly relevant for manufacturing companies. Altman had no idea that, almost 50 years later, people would still be using it and, indeed, using it more than ever. What is the Altman’s Z-score Formula? The Z-score Formula Here is the formula (for manufacturing firms), which is built out of the five weighted financial ratios: Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E A = Working Capital/Total Assets B = Retained Earnings/Total Assets C = Earnings Before Interest & Tax/Total Assets D = Market Value of Equity/Total Liabilities E = Sales/Total Assets Strictly speaking, the lower the score, the higher the odds are that a company is headed for bankruptcy. A Z-score of lower than 1.8 in particular, indicates that the company is heading for bankruptcy. Companies with scores above 3 are unlikely to enter bankruptcy. Scores in between 1.8 and 3 lie in a gray area. Breaking Down the Z: Now that we know the formula, it 's helpful to examine why these particular ratios are included. Let 's take a look at the significance of each one: Working
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