Z-Score Formula
The Simple Model for Predicting Bankruptcy

I recalled my memory about financial model for forecast bankruptcy. I can remember Z-Score formula by Altman. I test with original formula. I cannot believe it. This model was developed in 1968 but it work. Modern economist told us, cause of crisis from new financial product and very complicated. Uhhh, they lied me or not. With simple formula from Altman. Everybody can predicted bankruptcy before year end 2007

The Z-Score Formula

The Z-score formula for predicting bankruptcy was developed in 1968 by Edward I. Altman, a financial economist and professor at the Leonard N. Stern School of Business at New York University. The Z-score is a multivariate formula that measures the financial health of a company and predicts the probability of bankruptcy within two years.

Studies measuring the effectiveness of the Z-score have shown the model to be accurate with >70% reliability (Eidleman). The Z-score combines four or five common business ratios using a weighting system calculated by Altman to determine the likelihood of bankruptcy. The weighting system was originally based on data from publicly held manufacturers, but has since been modified for private manufacturing, non-manufacturing and service companies.

The original data sample consisted of 66 firms, half of which had filed for bankruptcy under Chapter 7. All businesses in the database were manufacturers, and small firms with assets of <$1million were eliminated. The original score was as follows:

Z = 1.2T1 + 1.4T2 + 3.3T3 + .6T4 + .999T5.

• T1 = Working Capital / Total Assets.
  : Measures liquid assets in relation to the size of the company.
• T2 = Retained Earnings / Total Assets.
  : Measures profitability that reflects the company's age and earning power.
• T3 = Earnings Before Interest and Taxes / Total Assets
  : Measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability.
• T4 = Market Value of Equity / Book Value of Total Liabilities.
  : Adds market dimension that can show up security price fluctuation as a possible red flag.
• T5 = Sales/ Total Assets.
  : Standard measure for turnover

Altman found that the ratio profile for the bankrupt group fell at -0.25 avg, and for the non-bankrupt group at +4.48 avg.

Zones of Discrimination:

• Z > 2.99 = "Safe Zone"
• 1.8 < 99 = "Grey Zone">
• Z < 8 = "Distress Zone">

From about 1985 onwards, the Z-scores have gained acceptance by auditors, management accountants, courts, and database systems used for loan evaluation (Eidleman). It has been used in a variety of contexts and countries, but was designed originally for publicly held manufacturing companies with assets of more than $1 million. Later revisions take into account the book value of privately held shares, and the fact that turnover ratios vary widely in non-manufacturing industries.

Reference:

• Z-Score Model for Predicting Wikipedia
• Edward Altman Site
  

Recent Paper from Altman Site

• Commentary: Bankruptcy With A Twist
• Why GM Should File for Bankruptcy with a DIP-Twist Help from Its Friends
• Defaults and Returns in the High-Yield Bond Market: The Year 2007 in Review and Outlook
• The Investment Performance and Market Size of Defaulted Bonds and Bank Loans: 2007 Review and 2008 Outlook
• Global Debt Markets in 2007: New Paradigm or the Great Credit Bubble?

Citigroup Z-Score 2007

T1 = 0.4471 , T2 = 0.0557 , T3 = 0.0362, T4 = 0.0733 , T5 = 0.0728

Z-Score Original Model = 0.6851