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Altman ZScore Described

ZScore Analysis

The Z-Score is a measureof a company'sheaith and utilizes scveralkey ratios for its formulation.

The model was developedin the late 1960'sby Edward Altman, Professorof Financeat NewYork University School of
Busincss.The model incorporatesfive weighted financial ratios into the calculationsof the Z-Score. ProfessorAltman
continuesto update thc model's coefficientsto reflect changing ways ofconducting business.The coefficient values
used in this SDS, Inc. SupplierFinancialAnalysis Notebook were publishedin 1993 in ProfessorAltman's book entitled
" ' C o r p o r a t eF i n a n c i a lD i s t r c s sa n d B a n k r u p t c y " , Z n de d i t i o n C o p y r i g h t 1 9 9 3b y J o h n W i l c y & S o n s ,I n c . I S B N
041t-552534.

ProlcssorAltman has dcfined 5 variablesthat cornpriscthe Z-score for public and private conpanies:

l. Xl Conrponentof Z-Score is defined as (Xl = Working Capital/TotalAssets).The ratio of Working Capital to Total
Assets is the Z-Score componentwhich is consideredto be a rcasonablepredictor of dccpening trouble for a
company. A cornpanywhich experienccsrepeatedopcrating lossesgenerallywill suffer a rcduction in working
capital rclative to its total assets.

2. The X2 Componentof Z-Score is dc fined as (X2 : RetaincdEarnings/1'otalAsscts).The ratio o f Retained Earnings

to Total Assets is a Z-Score componentwhich provides information on the extent to which a company has been
ablc to reinvcst its earningsin itself. An oldercompany will have had more time to accumulateearnings so this
rncasurementtendsto creatc a positive bias towards older companies

3. X3 Componentof ZScore is defined as (X3 = [rarningst]elore Taxes * Interest/TotalAssets).This ratio adjustsa

company'searningslor varying income tax factors and makcsadjustmentsfor levcraging due to borrowings. Thcsc
adjustrnentsallow urore effective measurementsof the company'sutilization of its assets.

4. The X4 Componentof ZScorc is defined as (X4 : Market Valuc of Equity/TotalLiabilities).This ratio gives an
indication of how much a company'sassetscan dccline in value before debts rnay excccd asscts Equity consists
of the rnarketvalue of all outstandingcommon and preferrcd stock. For a private company the book valuc olequity
i s u s c d f o r t h i s r a t i o .T h i s d e p c n d so n t h e a s s u m p t i o nt h a t a p r i v a t e c o m p a n yr c c o r d si t s a s s e t sa t m a r k e t ' ua l u c .

5. The X5 Componentof Z-Score is definedas (X5 : Net Sales/'r'otal.\ssets).This ratio mcasllresthe ability of thc
cornpany'sassetsto generatcsales.This ratio is not included in cheZ-Scorc of a private company.

T h e Z - S c o r e m o d e l f o r P u b l i c i n d u sctor ima pl a n i e s i s : Z - l . 2 X l + 1 . 4 X 2 + 3 . 3 X 3 t 0 . 6 X 4 + l . 0 X 5 . A h e a l t h y p u r r l i c
c o m p a n y h a s a Z > 2 . 9 9 ; i t i s i n t h e g r e y z o n1e.i8f 1 < Z < 2 . 9 9 ; i t i s u n h e a l t h y i f i t h a s a Z < 1 . 8 1

The Z-Score model for Privateindustrialcompaniesis:7. = 6.56 Xl + 3.26 X2 + 6.72X3 + 1.05X4.A healthyprivate
c o n r p a n y h a s a Z > 2 . 6i 0t i;s i n t h e g r e y z o n e ilf. l < Z < 2 . 5 9 ; i t i s u n h e a l t h y i ift h a s a Z < 1 . 1 .

N o t e : T h i s n t o d e l v v a s d e v e l o p e d i n t h el 9 6 0 s a n d u p d a t e d i n t h e l 9 9 0 s , u s i n g d a t a f r o n n r i d - s i : e d p u b l i c u n d p r i v a t e
ntanu.factttringfrnts. Therefore, the speciJic entpirical result.smay or may not be directly applicable to present
financialexpectalioils,parlicularlyforalargetechnical serviceorganizalionsuchasaTSDF. Themodel'sresults
should be revievveclin lhat context and usedfot'screening purposes only.

From Sourcing Decisiott Support, Inc.