A company’s creditworthiness and long-term financial strength are important aspects for stakeholders like lenders and investors. If you are planning to invest in a company’s equity (as an investor) or its bonds and debt instruments (as a lender), you need to know the entity’s risk for bankruptcy. The Altman Z-Score model helps you assess if a company is in financial distress.

In this article, we discuss what the Altman Z-Score is, look into the Altman Z-Score formula and calculator and explore the variants of this score for different types of companies.

## What is the Altman Z-Score

The Altman Z-Score is a value obtained using the credit-strength calculation proposed by the Altman Z-Score model. It takes into account different aspects of a company’s financials such as its working capital, retained earnings, Earnings Before Interest and Taxes (EBIT), equity market value, sales, and total assets and liabilities.

The standard Altman Z-Score model, developed by NYU Stern professor Edward Altman, applies to public manufacturing companies. The final output tells you if the company is likely to go bankrupt over the next two years or if it is financially strong.

## Altman Z-Score formula and calculation

The Altman Z-Score formula for public manufacturing companies uses five different variables. Each of these variables is a ratio. Check out the Altman Z-Score formula and the meaning of each variable in it.

**Altman Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E**

Where:

A = Working capital ÷ Total assets

B = Retained earnings ÷ Total assets

C = EBIT ÷ Total assets

D = Equity market value ÷ Total liabilities

E = Sales ÷ Total assets

To understand how the Altman Z-Score formula is used more clearly, let us discuss a hypothetical example. Consider the following details for a company.

Working capital = Rs. 5,00,000

Retained earnings = Rs. 3,00,000

EBIT = Rs. 2,50,000

Equity market value (aka market capitalisation) = Rs. 15,00,000

Sales = Rs. 30,00,000

Total assets = Rs. 20,00,000

Total liabilities = Rs. 10,00,000

Using the above values, here is what the five variables in the Altman Z-Score model will be:

Variable | Formula | Calculation | Value |

A | Working capital ÷ Total assets | Rs. (5,00,000 ÷ 20,00,000) | 0.25 |

B | Retained earnings ÷ Total assets | Rs. (3,00,000 ÷ 20,00,000) | 0.15 |

C | EBIT ÷ Total assets | Rs. (2,50,000 ÷ 20,00,000) | 0.125 |

D | Equity market value ÷ Total liabilities | Rs. (15,00,000 ÷ 10,00,000) | 1.5 |

E | Sales ÷ Total assets | Rs. (30,00,000 ÷ 20,00,000) | 1.5 |

Putting the values of these variables in the Altman Z-Score formula, we get the following result.

### Altman Z-Score:

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

= 1.2(0.25) + 1.4(0.15) + 3.3(0.125) + 0.6(1.5) + 1.0(1.5)

= 0.3 + 0.21 + 0.4125 + 0.9 + 1.5

= 3.3225

## Interpreting the Altman Z-Score

Once you calculate the Altman Z-Score, you need to interpret it correctly. The risk of a company going bankrupt depends on the score that you get as a result. Here is what different ranges of the Altman Z-Score mean for a public manufacturing company.

Altman Z-Score | What it means |

Below 1.81 | The company is in financial distress, with a high possibility of bankruptcy. |

1.81 to 2.99 | The company is in the financial grey area, with a moderate risk of bankruptcy. |

More than 2.99 | The company is financially safe, with a low possibility of bankruptcy. |

**Variants of the Altman Z-Score**

The Altman Z-Score model has a few variants for private manufacturing companies, non-manufacturing companies in developed markets and entities in emerging markets. Check out these variants below.

**Private manufacturing companies**

The formula for the Altman Z-Score for manufacturing companies in the private sector is:

**Altman Z-Score = 0.717A + 0.847B + 3.107C + 0.42D + 0.998E**

Where:

A = (Current assets — current liabilities) ÷ Total assets

B = Retained earnings ÷ Total assets

C = EBIT ÷ Total assets

D = Equity book value ÷ Total liabilities

E = Sales ÷ Total assets

**Non-manufacturing companies in a developed market**

Here, the Altman Z-Score formula is modified as shown below:

**Altman Z-Score = 6.56A + 3.26B + 6.72C + 1.05D**

Where:

A = (Current assets — current liabilities) ÷ Total assets

B = Retained earnings ÷ Total assets

C = EBIT ÷ Total assets

D = Equity book value ÷ Total liabilities

**Non-manufacturing companies in an emerging market**

The Altman Z-Score formula for these companies is as follows:

**Altman Z-Score = 3.25 + 6.56A + 3.26B + 6.72C + 1.05D**

Where:

A = (Current assets — current liabilities) ÷ Total assets

B = Retained earnings ÷ Total assets

C = EBIT ÷ Total assets

D = Equity book value ÷ Total liabilities

## Limitations of the Altman Z-Score

The Altman Z-Score model can be useful to assess a company’s financial strength and predict its likelihood of going bankrupt. However, it has a few limitations that you must be aware of before you rely entirely on this score.

**Heavy reliance on past data: **The Altman Z-Score model relies heavily on past data. However, businesses are constantly changing and any new material financial information is often ignored, leading to possibly skewed results.

**Low accuracy: **With the Altman Z-Score, you can predict if a company is likely to go bankrupt — but not when it is likely to happen. The lack of accuracy in this aspect can be vague and confusing for investors.

**Abnormalities overlooked: **Some businesses may be financially sound, but abnormalities like a negative working capital cycle could pull the Altman Z-Score down. However, these abnormalities may not be indicators of insolvency at all.

**Not suitable for early-stage businesses: **The Altman Z-Score model is not well suited for companies that are in the early stages of their business. These entities may be growing rapidly but may not be profitable yet, leading to misleading scores.

## Conclusion

To overcome the limitations, ensure that you factor in other indicators as well — like ratio analysis, trend analysis, cash flow analysis and industry comparison. Using these techniques along with the Altman Z-Score can give you a holistic overview of a company’s financial strength and creditworthiness.