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What is Altman's Z-score? How to calculate it?

 Altman’s Z score: It was published by Edward Altman in 1968.It helps investors to analyse the financial strength of a company and measure the bankruptcy of a company.  There are three zones in Altman’s z-score:

·         Safe zone

·         Grey zone

·         Danger zone

Safe Zone: If z-score is more than 2.99 that company is comes under safe zone.

Grey Zone: If z-score is between 1.81 and 2.99 then that company comes under grey zone.

Danger Zone: If z-score is less than 1.81 then that company is in danger zone.

Formula:

1.2*(working capital/Total Assets) +1.4*(Retained Earnings /Total Assets) +3.3*(Earnings before interest and tax/Total Assets) +1.6*(The equity market value/Total Assets) +0.999*(Total Sales/Total Assets)

With the help of this formula investors can predict the bankruptcy of a company within 2 years. It acts as a tool for making investment decision.

Example: Find out the Altman Z-score with the help of following information of XYZ Company:

Total Assets = Rs. 5, 08,470

Current Assets = Rs. 1, 00,580

Current liabilities =Rs. 78,000

Sales = Rs. 1, 95,420

Cost of goods sold =Rs. 25900

Operating expense = Rs. 17,000

Dividend paid to shareholders =Rs. 3,000

Tax rate =25%

Number of outstanding shares = 20,000

Market value of share = Rs. 8.2 per share

Interest expense =Rs. 12,850

Solution: Working capital =Current Assets-Current Liabilities

=100580-78000

= Rs. 22,580

Particulars

Amount

Sales

195420

Less: Cost of goods sold

25900

Gross profit

169520

Less: Operating expenses

17000

Earnings before interest and tax

152520

Less: Interest expenses

12850

Earnings before tax

139670

Less: Tax rate 25%

34918

Net income

104,752

Less: Dividend paid to common stockholders

30000

Retained earnings

74752

 

Market value of per share =Rs.8.2

Number of share outstanding = 20,000

Equity market value =20,000*8.2 =Rs. 164000

Altman z- score:

=1.2*(working capital/Total Assets) +1.4*(Retained Earnings /Total Assets) +3.3*(Earnings before interest and tax/Total Assets) +1.6*(The equity market value/Total Assets) +0.999*(Total Sales/Total Assets)

= 1.2*(22580 /508470) +1.4*(74752 /508470) +3.3*(152520 /508470) +1.6*(164000 /508470) +0.999*(195420 /508470)

= (1.2*0.0444) + (1.4*0.1470) + (3.3*0.2999) + (1.6*0.3225) + (0.999*0.3843)

=0.05328+0.2058+0.98967+0.516+0.3839157

= 2.15

The z score of company XYZ is 2.15.It is between the score of 1.81 and 2.99. So, it comes under grey zone. It means company will grow more in future and the chance of company being bankrupt in future is less.

Example: Company PQR market share price is Rs. 9 per share. Investor wants to invest in PQR Company. But the Company’s profit is decreases in past 2 years. Investor use Altman z-score to know the financial position of a company by checking the bankruptcy level to save its future investment for earning loss. Following information is given:

Working capital =Rs. 18,000

Total assets =Rs. 3, 50,000

Retained earnings =Rs. 35,000

Sales = Rs. 2, 00,500

Market value of shares = Rs. 450,000

Number of outstanding shares = 50,000

Earnings before interest and tax = Rs.105000

Solution: Altman z- score:

=1.2*(working capital/Total Assets) +1.4*(Retained Earnings /Total Assets) +3.3*(Earnings before interest and tax/Total Assets) +1.6*(The equity market value/Total Assets) +0.999*(Total Sales/Total Assets)

=1.2*(18000/350000) +1.4*(35000 /350000) +3.3*(105000/350000) +1.6*(450000/350000) +0.999*(200500/350000)

= (1.2*0.0514) + (1.4*0.1) + (3.3*0.3) + (1.6*1.285) + (0.999*0.573)

=0.06168+0.14+0.99+2.056+0.572

= 3.82

The z score is 3.82. It means company is in green zone and it does not become bankrupt within two years.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comments

  1. PMMarch 13, 2023 1:31 am

    Excellently done

    ReplyDelete
  2. Anthony ConstantinouJuly 27, 2023 7:29 pm

    Altman's Z score: It was released in 1968 by Edward Altman.It aids investors in evaluating a company's financial stability and gauging its likelihood of bankruptcy. The three zones in Altman's z-score are as follows:

    ReplyDelete

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