Altman Z-score

The Altman Z-score is a formula that combines several financial ratios into a single number meant to estimate how likely a company is to go bankrupt within the next couple of years. It was developed by finance professor Edward Altman in the late 1960s and is still widely used today as a quick screen for financial distress.

The score blends five inputs: working capital relative to total assets, retained earnings relative to total assets, operating income relative to total assets, market capitalization relative to total liabilities, and revenue relative to total assets. Each ratio captures a different angle on financial health, liquidity, accumulated profitability, current earning power, market confidence in the company's solvency, and asset efficiency, and each gets weighted and summed into one composite score.

The resulting number is compared against established thresholds. A high score suggests a low probability of bankruptcy, a low score signals real distress risk, and scores in between fall into a gray zone where the company bears watching but isn't clearly in danger. Investors use it as an early warning tool, especially for companies carrying heavy debt loads or operating in cyclical industries where a downturn could threaten solvency.

The Altman Z-score works best on manufacturing and industrial companies, which is the type of company it was originally built around, and is less reliable for financial companies, whose balance sheets look structurally different, or for early-stage companies with little revenue or retained earnings history. It's a useful screening tool rather than a definitive verdict, a low score is a prompt to dig into the balance sheet and cash flow statement, not a standalone reason to avoid a stock.