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In the early 60's Edward Altman, using
Multiple Discriminant Analysis combined a set of 5 financial ratios to
come up with the Altman Z-Score. This score uses statistical techniques
to predict a company's probability of failure using eight weighted
variables from a company's income statement and balance sheet plus the
company's market cap.
Generally speaking, the lower the score, the higher the odds of
bankruptcy.
Companies with
Z-Scores above 3 are considered to be healthy and, therefore, unlikely
to enter bankruptcy. Scores in between 1.8 and 3 lie in a grey area. It
has been reported that real world application of the Z-Score
successfully predicted 72% of corporate bankruptcies two years prior to
these companies filing for Chapter 7. |
