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Z-Score Concept
Z-Score, developed in the 60´s by Edward
Altman, is a model of bankruptcy prediction and can be used to detect
financial problems in companies listed on the Stock Exchange. The
Z-Score calculation formula uses several ratios that derive from the
financial demonstrations, namely the following:
X1 = Working Capital / Assets’ Total
X2 = Retained Profits / Assets’ Total
X3 = Profits before financial charges and
taxes / Assets’ Total
X4 = Market Capitalization / The
Accounting Value of Liabilities
X5 = Sales / Assets’ Total
To calculate Z-Score, the previous ratios
are added after they have been multiplied by a certain weighting factor:
Z = 1,2.X1 + 1,4.X2 + 3,3.X3 + 0,6.X4 + X5
According to the model’s authors, a result
below 1,81 indicates a strong probability of bankruptcy, while a result
above 3 indicates a low probability of bankruptcy.
Naturally that, like other
financial
analyses models, Z-Score should be prudently analyzed mainly in regards
to the quality of the data originating from financial demonstrations –
if the accountancy data is far from reality, the conclusion to take from
the analyses of the Z-Score result doesn’t have any validity.
Translated from Portuguese
by Susana Saraiva, Portuguese-English and English-Portuguese translation
specialist. Contact: spams@sapo.pt.
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