J. Miller and Company Blog

August 5, 2008

Z-Score – 1 Dangerous Number

The Altman Z Score is 1 beautiful number which predicts 1 dangerous outcome: your company’s likelihood of declaring bankruptcy!

Wouldn’t it be nice if you could tell, especially when things are tough, how close you were to the edge?

The Z Score uses 5 ratios, weights them by degree of importance, then adds them together to measure the company’s overall health.

4 of the 5 have as their denominator Total Assets or the value of all the company’s holdings. The 5th uses Current Liabilities.

The numerators are EBIT, Market Value of Equity, Net Sales, Working Capital & Retained Earnings.

Plug these 10 figures from your current financial statement into the calculator at the Credit Guru website (http://www.creditguru.com/CalcAltZ.shtml) and within seconds (the miracle of computers) you’ll see your score ranging from above 3 (considered “safe”) to below 1.8 (“Probability of Financial embarassment is very high.”).

This is all great EXCEPT that your numbers have to be PERFECT in order to trust the calculation. Read my post on Asset Valuation on this blog to understand how very slippery a slope we tread when we start to throw numbers around and make far-reaching decisions based on the outcome.

As a business owner it is imperative that you know and understand your financial and job cost numbers inside and out; that you know how the information is gathered, how it is entered, how accuracy is proofed, how timeliness is maintained and how consistency throughout is upheld. Without such attention to details, you might interpret the numbers incorrectly, you might interpret them correctly but inconsistently, you might fail to use them at all.

And at this time in our economy, such a failure could well prove fatal.

Metrics ,