to produce value for the owners (EVA) Economic Value Added, cash flow return. Seldom, however, should you use any of the Z Score measures as your only means of analysis. Keywords: bankruptcy prediction Z-Score ratios financial distress. The Z Score model is a tool that can complement your other analytical tools. At last count, for example, Google offered 308,000 links to the phrase, “Z Score”. This measure is far from perfect, but it’s easy to calculate in Excel and many users continue to find it useful. The model uses unadjusted accounting data it uses data from relatively small firms, and it uses data that today is nearly 60 years old.Īnd yet, despite these concerns, the original Z Score model is the best-known and most widely used measure of its kind. How accurately does the Z Score measure economic bankruptcy? The original model has drawn several statistical objections over the years. It is a measure of corporate financial distress, a measure of economic bankruptcy. It is instead a measure of how closely a firm resembles other firms that have filed for bankruptcy. The Z Score is not intended to predict when a firm will file a formal declaration of bankruptcy. If the score is less than 1.10, it’s headed for bankruptcy. Therefore, according to the table, if a company’s Z2 score is greater than 2.60, it’s currently safe from bankruptcy. The Z Score is for public manufacturing companies the Z1 Score is for private manufacturing companies, and the Z2 is for general use. To deal with these problems, Altman used his original data to calculate two modified versions of the Z Score, shown above. But since the Z Score expects a value that is common to manufacturing, it could be biased in such a way that a healthy jewelry store looks sick and a sickly grocery store looks healthy. Jewelry stores, for example, have a low asset turnover while grocery stores have a high turnover. This ratio varies significantly by industry. The other problem is X5, Assets Turnover. Obviously, if a firm is not publicly traded, its equity has no market value. One of these ratios is X4, the Market Value of Equity divided by Total Liabilities. Two of the ratios shown in the figure have tended to limit the usefulness of the original Z Score measure. The table shows how these measures are used to calculate the three versions of the Z Score.
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