Altman Z-Score

Formula

Z = 1.2×A + 1.4×B + 3.3×C + 0.6×D + 1.0×E

A = Working Capital / Total Assets; B = Retained Earnings / Total Assets; C = EBIT / Total Assets; D = Market Value of Equity / Total Liabilities; E = Sales / Total Assets

How to interpret it

Z > 2.99 means the "safe zone" (low bankruptcy risk). Between 1.81 and 2.99 is the "grey zone" (uncertain, watch closely). Below 1.81 is the "distress zone" (high risk of financial difficulty). These thresholds are for the classic model; service and emerging-market companies use different versions.

Example

If a company's Z-Score is 3.5, it's in the safe zone with low short-term bankruptcy risk. A company with a Z-Score of 1.5 is in the distress zone and warrants closer examination.

Common uses

• Screen out companies with high bankruptcy risk before adding them to a portfolio.
• Flag financially fragile businesses sitting in the distress zone (below 1.81).
• Track a company's Z-Score trend to catch deteriorating financial health early.
• Combine the Z-Score with valuation so a cheap stock isn't actually a failing one.

Limitations

• The Altman Z-Score isn't suitable for financial companies (banks, insurers) because their balance-sheet structure differs.
• It relies on historical data and can't foresee sudden crises or one-off events.
• It's a risk indicator, not a definitive bankruptcy prediction.