Altman Z-Score Calculator: Bankruptcy Risk Formula

Altman Z-Score Calculator

The Altman Z-score is a formula that estimates how likely a company is to go bankrupt within the next two years. It combines five financial ratios, taken from a company's balance sheet and income statement, into a single number. Economist Edward Altman created it in 1968 to give lenders and investors a quick way to check a company's financial health.

Altman Z-Score formula

The Altman Z-score adds five ratios, each multiplied by a fixed weight:

$$Z = 1.2X_1 + 1.4X_2 + 3.3X_3 + 0.6X_4 + 1.0X_5$$

• $X_1$ = Working capital ÷ Total assets
• $X_2$ = Retained earnings ÷ Total assets
• $X_3$ = EBIT ÷ Total assets
• $X_4$ = Market value of equity ÷ Total liabilities
• $X_5$ = Sales ÷ Total assets

This is Altman's original 1968 model. He built it for public manufacturing companies, so it uses the market value of equity (share price multiplied by shares outstanding) rather than book value.

What each term means

• Working capital: current assets minus current liabilities. It shows whether a company can cover its short-term bills.
• Retained earnings: profit the company has kept and reinvested since it started, instead of paying out as dividends.
• EBIT: earnings before interest and taxes. It measures profit from normal operations, separate from financing and tax choices.
• Market value of equity: the current share price multiplied by the number of shares outstanding.
• Total liabilities: everything the company owes, short-term and long-term combined.
• Sales: total revenue from the company's business over the period.
• Total assets: everything the company owns, short-term and long-term combined.

How to calculate the Altman Z-Score

1. Find the seven inputs above on the company's balance sheet and income statement.
2. Divide each pair of numbers to get the five ratios, X1 through X5.
3. Multiply each ratio by its weight: 1.2, 1.4, 3.3, 0.6, and 1.0.
4. Add the five results together. The sum is the Z-score.

Altman Z-Score example

Suppose a company reports these figures, in millions of dollars:

First, calculate the five ratios:

• X1 = 50 / 800 = 0.0625
• X2 = 200 / 800 = 0.25
• X3 = 100 / 800 = 0.125
• X4 = 500 / 400 = 1.25
• X5 = 600 / 800 = 0.75

Then apply the weights and add the results:

Z = 1.2(0.0625) + 1.4(0.25) + 3.3(0.125) + 0.6(1.25) + 1.0(0.75) Z = 0.075 + 0.35 + 0.4125 + 0.75 + 0.75 Z = 2.34

A score of 2.34 falls in the grey zone, described below.

How to interpret the Altman Z-Score

The Z-score sorts a company into one of three zones:

• Z above 2.99 — safe zone. Low probability of bankruptcy within two years.
• Z between 1.81 and 2.99 — grey zone. The model cannot classify the company as safe or distressed. Check other financial measures too.
• Z below 1.81 — distress zone. High probability of bankruptcy within two years.

These cutoffs come from Altman's original research on manufacturing companies. They are a guide, not a guarantee.

Limitations of the Altman Z-Score

The original formula was built and tested on public manufacturing companies, so it fits that group best. It is less reliable for banks, insurers, and other financial firms, since their balance sheets do not fit the same ratios. It also struggles with young companies, which often report negative earnings and have little retained earnings. A low or negative working capital, EBIT, or retained earnings figure can push the score down sharply even when the company is otherwise stable. The model reads a single set of financial statements. It does not account for the wider economy, industry trends, or accounting changes that can inflate the underlying ratios.

Later versions close some of these gaps. The Z′-score replaces market value of equity with book value, so it can be used for private companies. The Z″-score drops the sales ratio entirely, which makes it better suited to non-manufacturing and emerging-market companies. Other bankruptcy models, such as the Ohlson O-score and the Zmijewski score, use different statistical methods and different ratios.

History of the Altman Z-Score

Edward Altman, a finance professor at New York University, published the Z-score model in 1968. He studied 66 manufacturing companies, half of which had filed for bankruptcy, and used a statistical method called multiple discriminant analysis to find which financial ratios separated the two groups. In his original test, the model correctly predicted bankruptcy in 95% of cases one year before it happened, and in 72% of cases two years before. The model remains one of the most cited tools in corporate finance and credit analysis.

Frequently asked questions

What is a good Altman Z-score?

A score above 2.99 places a company in the safe zone. It means the model predicts a low probability of bankruptcy within two years.

What does a negative Altman Z-score mean?

A negative score usually comes from negative working capital, retained earnings, or EBIT. It signals severe financial distress and places the company well inside the distress zone.

Can the Altman Z-score be used for private companies?

The original formula needs a share price, so it does not work for companies that are not publicly traded. Analysts use the Z′-score instead, which replaces market value of equity with book value of equity.

How accurate is the Altman Z-score?

In Altman's original study, the model correctly predicted bankruptcy 95% of the time one year in advance and 72% of the time two years in advance, for public manufacturing companies. Accuracy tends to be lower for other industries and for use outside the original sample.

How is the Altman Z-score different from a credit rating?

A credit rating from an agency such as Moody's or S&P combines financial data with analyst judgment. The Altman Z-score applies a fixed formula to reported financial statements, so two people calculating it from the same figures get the same result.

Can the Altman Z-score be used for startups?

It works poorly for startups. Startups often report negative earnings, have little or no retained earnings, and have a short financial history, none of which the original formula was built to handle.

References

1. Altman, E. I. (1968). "Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy." The Journal of Finance, 23(4), 589–609.
2. "Altman Z-score." Wikipedia.