9.21 Altman’s Corporate Credit Scoring System

In the early 1960s, Dr. Edward Altman of NYU used “Multiple Discriminant Analysis,” combining a set of 5 financial ratios to come up with the “Z-Score.” This score assesses a company’s probability of failure or bankruptcy, using 8 variables from a company’s financial statements. The formula, including five ratios and their coefficients, follows.

It is notable that the principal ratio, i.e., the one with the largest coefficient is ROA (EBIT / TA)!

Z =

3 (EBIT / TA)

+ 1.4 (RE / TA)

+ 1.2 (WC / TA)

+ 1.0 (S / TA)

+ 0.6 (MV-Eq. / BV-Debt)


TA Total Assets WC Working Capital = Current Assets less Current Liabilities
EBIT Earnings before Interest and Taxes Sales Sales
RE Retained Earnings MV-  Eq Market Value of Firm’s Equity
BV- Debt Book Value of Firm’s Debt

Interpreting the Z Score:

Z-SCORE ABOVE 3.0 –The company is OK, according to these data.

Z-SCORE BETWEEN 2.7 and 2.99 – Alert. One should exercise caution.

Z-SCORE BETWEEN 1.8 and 2.7 – There is a high probability that the company will go bankrupt within 2 years of the date of the given financial figures.

Z-SCORE BELOW 1.80 – Probability of failure is very high.


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Corporate Finance Copyright © 2023 by Kenneth S. Bigel is licensed under a Creative Commons Attribution 4.0 International License, except where otherwise noted.

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