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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
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      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
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      • The Roles of Deal Arrangers and Book Runners in Securitization
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      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
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      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
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      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
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      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
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      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
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Home Economy

What Is the Altman Z-Score and How to Use It?

John Goodden by John Goodden
September 11, 2023
in Economy
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Altman Z-Score
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The Altman Z-Score is a formula that can help investors and creditors assess the financial health and risk of a company. It was developed by Professor Edward Altman in 1968 as a way to predict the probability of bankruptcy within two years. The Altman Z-Score is based on five financial ratios that measure the profitability, leverage, liquidity, solvency, and activity of a company. These ratios are weighted by coefficients that were estimated using a sample of manufacturing firms that had either survived or filed for bankruptcy.

How an Altman Z-Score is Calculated

The Altman Z-Score formula is as follows:

Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5

Where:

X1 = working capital / total assets

X2 = retained earnings / total assets

X3 = earnings before interest and taxes / total assets

X4 = market value of equity / total liabilities

X5 = sales / total assets The Altman Z-Score can be interpreted as follows12:

A score below 1.8 indicates a high risk of bankruptcy.

A score between 1.8 and 3 indicates a moderate risk of bankruptcy.

A score above 3 indicates a low risk of bankruptcy.

The Altman Z-Score can be used by investors and creditors to evaluate the financial performance and stability of a company, and to compare it with other companies in the same industry or sector. It can also be used to identify potential opportunities or threats in the market, such as undervalued or overvalued stocks, or distressed or healthy companies.

Success of Altman Z-Score

In its initial test the Altman Z-Score system was shown to be 72% accurate in predicting bankruptcy 2 years before the event. In further testing looking at 3 periods over the next 31 years the model was found to be 80-90% accurate in forecasting insolvency within 1 year.

Limitations of Altman Z-Score

However, the Altman Z-Score also has some limitations that users should be aware of:

  • It was originally designed for manufacturing firms, and may not be applicable to other types of businesses, such as service or non-manufacturing firms.
  • It relies on accounting data that may be subject to manipulation or errors, and may not reflect the true value or performance of a company.
  • It does not take into account other factors that may affect the financial situation or outlook of a company, such as macroeconomic conditions, industry trends, competitive advantages, or growth potential.

In Conclusion

Therefore, the Altman Z-Score should not be used as the sole criterion for making investment or lending decisions, but rather as one of the tools that can provide useful insights and information. Users should also conduct their own due diligence and analysis before making any financial judgments or actions.

Tags: Altman Z-Scorebankruptcy
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  • Home
  • About
  • Podcast
    • Summaries
    • Articles
  • Invoice Finance
    • Basics
      • What is Invoice Finance?
      • What is Reverse Factoring?
      • What are Trade Receivables?
      • What is the Cash Conversion Cycle?
      • What is Days Inventory Outstanding?
      • What is Days Sales Outstanding?
      • What is Days Payable Outstanding?
    • Advanced
      • Invoice Validation and Fraud Detection
      • Reasons Why Invoice Finance is Better than a Bank Loan
      • How to Choose the Right Factoring Firm for Your Business
      • A Closer Look at Factoring Agreements
      • What is Trade Receivables Securitisation?
      • Breakdown of the Costs for Factoring
    • Factoring
      • Why Companies Use Invoice Factoring
      • What Companies are Suitable for Invoice Factoring?
      • Factoring and Invoice Discounting
      • How Factoring Works
      • Asset Based Lending
      • Is Factoring Right for Your Company?
      • Accounting for Factoring
      • How a Company Enters into a Factoring Agreement
      • The Costs Involved in Factoring
      • Changing Factoring Company
      • The Relationship Between the Factoring Company and the Debtor
      • Legal Aspects of a Factoring Company Pursuing Payment Through the Courts
      • Factoring in the Construction Industry
    • Fraud
      • Types of Invoice Fraud
      • How to Combat Invoice Fraud
    • E-Invoicing
      • Legal Status of Electronic Invoicing
      • The Benefits of E-Invoicing
      • Implementing an E-Invoice System
      • E-Invoicing Adoption in Mexico and The Rest of the World
  • Brokers
    • UK Brokerage Firms
  • Factoring Firms
    • Europe
      • UK
      • France
      • Germany
      • Italy
      • Spain
      • Holland
    • North America
      • USA
      • Canada
    • Australasia
      • Australia
      • New Zealand
  • Hi-Tech
    • Digital Platform/IT/Software Providers
    • UK Fintech
    • Articles
      • Enhancing Fintech Interoperability: Digitalizing Trade Documents for Efficiency and Security
      • The 7 Types of AI and Their Implications for the Future
      • Transforming Trade Finance: The Role of AI
      • The Different Programming Languages Used in Fintech Companies and Financial Institutions
      • UK and US Authorities Intervene in AI Sector
      • Web3 Applications and the Future of Trade Finance
      • What is Web 3?
      • What Can Fintech do for You?
      • What is Fintech?
      • Tokenisation of Finance
      • Payment Services in the Invoice Finance Sector
      • What is ChatGPT and Why the Fuss?
  • Rating Agencies
  • Securitisation
    • Deal Arrangers
    • Book Runners
    • Articles
      • The Roles of Deal Arrangers and Book Runners in Securitization
      • What is Trade Receivables Securitisation?
      • The Appeal of Trade Receivables Securitisation
      • Risk Mitigation for Trade Receivables Securitisation
  • Legal
    • Law Firms
    • Articles
      • A Guide to Accounts Receivable Purchase Agreements and Invoice Discounting Agreements
      • The Challenges of KYC and AML Checks
      • What is The Model Law on Electronic Transferable Records (MLETR)?
      • Snapshot of Factoring Legal Schemes in England and Wales
      • How are UK Factoring Firms Regulated?
      • What is ISO20022 and Why is it Important?
  • Rates
  • Economy
    • Economic Indicators
    • Articles
      • The Collapse of the Russian Rouble: An Historical Analysis and Current Implications
      • The Current State of the UK Economy
      • Economic Forecast for the UK in 2023
      • Economic News for 2022
      • Financial Crisis or Not?
      • Credit Suisse Bailout
  • Credit Insurers
    • Credit Insurers
    • Articles
      • Credit Insurance Legal Aspects
      • Credit Insurance in Trade Receivables Financing
      • The Benefits of Credit Insurance in Invoice Finance
      • Eligibility Requirements for Capital Relief by Using Credit Insurance
      • What are Export Credits and Country Risk Classifications?
      • How the War in Ukraine Affects the Price of Credit Insurance for Trade Finance
  • Associations
  • ESG
    • ESG Articles
    • ESG Resources
  • Crypto Finance
    • Ripple (XRP) Wins Latest Battle with SEC
    • UK Passes Financial Services and Markets Act 2023
    • Latest about the UK Regulatory Proposal for Crypto Assets
    • How will MiCA (Markets in Crypto Assets) Regulation Affect Trade Finance and the Banking System?
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    • How DeFi Fulfils the Functions of Finance
    • Taxonomy of Crypto Assets
    • Crypto Currencies
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    • Interview with Tradeshift
    • Interview with Kyriba
    • Interview with Orbian
    • Interview with Crossflow
    • Interview with Dancerace
    • Interview with BlackLine
    • Interview with Novicap Part One
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    • Interview with vabble
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