How the Altman Z-Score works
The Altman Z-Score is a bankruptcy-prediction model published by NYU professor Edward Altman in 1968. It combines five financial ratios into a single score using fixed weights derived from a study of publicly traded manufacturing companies: Z = 1.2·X1 + 1.4·X2 + 3.3·X3 + 0.6·X4 + 1.0·X5. The lower the score, the closer a firm's ratio profile resembles companies that later went bankrupt.
The five ratios
- X1 = Working capital / Total assets — short-term liquidity relative to the size of the firm. Working capital is current assets minus current liabilities.
- X2 = Retained earnings / Total assets — cumulative reinvested profitability; young or chronically unprofitable firms score low here.
- X3 = EBIT / Total assets — operating return on assets, the heaviest-weighted ratio (coefficient 3.3).
- X4 = Market value of equity / Total liabilities — how far asset values could decline before liabilities exceed them, using the market's valuation of the equity cushion.
- X5 = Sales / Total assets — asset turnover, how efficiently assets generate revenue.
Reading the zones
In Altman's original cutoffs, a score above 2.99 places the company in the safe zone, 1.81 to 2.99 is the grey zone of uncertainty, and below 1.81 is the distress zone, associated with elevated bankruptcy risk within roughly two years in the original study.
Common interpretation mistakes
- The original model was built for publicly traded manufacturers. Private firms should use the Z' variant and non-manufacturers the four-ratio Z'' variant; it is not designed for banks and other financial companies at all.
- A single score is a snapshot. Track the Z-Score over several quarters or years — a drifting score tells you far more than one reading.
- Negative working capital or retained earnings are entered as negative numbers; they legitimately drag the score down rather than invalidating it.
When to escalate to a specialist
For decisions involving loan covenants, credit approval, M&A diligence, or regulatory filings, cross-validate this calculator's output with a CFO, accountant, or credit analyst. The math is reliable; the interpretation context is not always captured by a single formula.