Altman's Z-score model is used to determine the likelihood of company bankruptcy in the next two years..
The bankruptcy risk assessment model was proposed by Professor Edward Altman in 1967 G. for manufacturing companies. After he repeatedly revised the model, changing the coefficients. The model has been adapted for both non-manufacturing companies, and for emerging markets.
Altman's invention lies in the selection of coefficients and their weights.
Analysis, proposed by Altman, determines the likelihood of bankruptcy risk, using the results of the company's reporting.
The formula for calculating the classical model is as follows:
1,2A + 1,4B + 3,3C + 0,6D + 1E
A = difference between short-term assets and short-term liabilities / total assets
B = retained earnings after dividend payment / total assets
C = earnings before interest and taxes / total assets
D = current market value of capital / total liabilities
E = sales revenue / total assets
Based on the coefficients in the formula, it is seen, that Altman places the greatest weight on earnings before interest and taxes. At its core, this is close to operating cash flow., which indicates the amount of money, which the company brings from its current, regular activities.
When calculating using the Altman model, the key values are 1,8 And 3.
If the calculated result according to the model turned out to be:
• equal or less 1,8 Is a red signal, the company is at a high risk of bankruptcy
• from 1,8 to 3 Is a gray signal, the company is at risk of bankruptcy
• equal 3 and higher is a green signal, company without risk of bankruptcy
In fact, confirming the validity of Altman's model, is the achievement in 2007 G. mean Z-score in 1,81 for American companies. This was followed by a financial crisis in 2008 G., followed by a series of company defaults in 2009 G.
Altman Z-score model with accuracy 72% gives a result when predicting bankruptcy two years before its fact.
Altman's model is now widely used in risk assessment, along with such indicator as Value at Risk (Where).
Example
For a stock investor, an approximation to the value 1,8 is a disturbing sign, therefore, these promotions may be on sale. And vice versa, improvement of the coefficient with approaching 3 can serve as a trigger to buy shares.
Due to industry differences and differences in economies across countries, the Altman model should be used with caution.. For a better analysis to determine the risk of bankruptcy, it is worth considering a wide range of indicators..
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