The Altman Z Score was designed to predict the probability that a company would go bankrupt within two years using financial metrics that assess solvency, profitability, leverage, liquidity, and turnover.
Today, we use it to help assess a company’s fundamental quality.
Use these factors:
X1 = Working Capital/Total Assets
X2 = Retained Earnings/Total Assets
X3 = EBITDA/Total Assets
X4 = Market Value of Equity/Total Liabilities
X5 = Net Sales/Total Assets
Z = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5
Z = 6.56*X1 + 3.26*X2 + 6.72*X3 + 1.05*X4
These are general pointers. Be sure to read the full discussion to see the pros and cons of each.
The more working capital there is compared to the total assets, the better the liquidity situation.
The lower the ratio, the company is funding assets by borrowing instead of through retained earnings.
EBITDA / Total Assets is a variation of ROA. Instead of net income, EBIT is used for the numerator. This ratio looks at the company’s ability to generate profits from its assets before deducting interest and taxes.
This ratio is supposed to show you how much of the company’s market value could decline before liabilities exceed assets. If the stock price is high, then this ratio also goes up.
Simply asset turnover. The more money you can generate from assets, the better.