Altman Z-Score: Definition, Formula, and How to Interpret It

What it is

The Altman Z-score is a financial metric that estimates a publicly traded company’s likelihood of bankruptcy. Developed by NYU Stern professor Edward Altman in 1967, the model combines five financial ratios to gauge profitability, leverage, liquidity, solvency, and activity. It has been widely used to assess corporate credit risk and financial distress.

The original Z-score formula

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

Where:
* A = Working capital / Total assets
* B = Retained earnings / Total assets
* C = Earnings before interest and taxes (EBIT) / Total assets
* D = Market value of equity / Total liabilities
* E = Sales / Total assets

All inputs can typically be found on a company’s annual financial statements (e.g., 10‑K). Note that D uses market value of equity, so the score can fluctuate with the stock price.

Interpreting the score

Common interpretation thresholds (original model for public manufacturing firms):
* Z > 3.0 — “Safe” zone (low probability of bankruptcy)
* 1.8 < Z < 3.0 — “Grey” zone (moderate risk)
* Z < 1.8 — “Distress” zone (high risk of bankruptcy)

More recent commentary from Professor Altman suggests that modern data may shift concern toward much lower values (closer to 0), but the traditional thresholds remain useful as a rule of thumb.

Variants and applicability

• Original model: designed for publicly traded manufacturing companies.
• Altman Z‑Score Plus and later variants: extended to private companies, non‑manufacturing firms, and non‑U.S. companies with adjusted coefficients and inputs to improve accuracy across different contexts.
  Use the version appropriate to the company type and region.

Practical uses

• Credit assessment: lenders and bond analysts use the score to screen corporate creditworthiness.
• Investment screening: investors may incorporate the Z‑score when evaluating downside risk and financial stability.
• Monitoring: boards and management can use it as an early‑warning indicator of deteriorating financial health.

Limitations and caveats

• Not definitive: the Z‑score is a statistical predictor—use it alongside other fundamental and market analyses.
• Industry differences: capital structure and typical ratios vary by industry; compare scores with industry peers.
• Market sensitivity: because D uses market equity value, stock price volatility can distort short‑term readings.
• Accounting effects: changes in accounting policies, one‑time items, and off‑balance‑sheet exposures can affect inputs and accuracy.
• Time and recalibration: the model was developed decades ago; later variants aim to address structural changes in markets.

Historical note: 2008 financial crisis

In 2007 the median Altman Z‑score for a set of companies was about 1.81, very near the traditional distress threshold. Edward Altman interpreted rising aggregate distress as a sign of an imminent credit problem. The 2008 crisis began with problems in mortgage‑backed securities, but corporate defaults rose sharply afterward (notably in 2009), illustrating how elevated Z‑scores signaled broader systemic strain.

Key takeaways

• The Altman Z‑score is a compact, widely used tool for assessing bankruptcy risk.
• It combines five balance‑sheet and income‑statement ratios into a single score.
• Apply the correct model variant for the company type and use the score as one input among many.
• Be mindful of market and industry context and recent refinements to the model.

Further reading

Consult Edward Altman’s published papers and the Altman Z‑Score Plus materials for model variants, empirical validation, and industry‑specific guidance.