How to Calculate the Altman Z-Score

How to calculate the Altman Z-score, step by step

The Altman Z-score is five ratios, weighted and added, that answer one question: how likely is this company to go bankrupt in the next two years? Edward Altman published it in 1968 after studying 66 manufacturing companies — half bankrupt, half healthy — and finding that five ratios together separated the two groups far better than any one ratio alone. The score is a screen, not a verdict: it tells you which companies need a closer look, not which ones will fail.

The formula is Z = 1.2 × (working capital ÷ total assets) + 1.4 × (retained earnings ÷ total assets) + 3.3 × (EBIT ÷ total assets) + 0.6 × (market value of equity ÷ total liabilities) + 1.0 × (sales ÷ total assets). Working capital is current assets minus current liabilities, retained earnings are the profits the company has kept, EBIT is earnings before interest and tax, market value of equity is the share price times the shares outstanding, total liabilities are everything the company owes, sales are the revenue for the year, and total assets are everything the company owns.

The worked example, line by line. Step 1 — ratio A: $100,000 ÷ $1,000,000 = 0.10, and 1.2 × 0.10 = 0.12. Step 2 — ratio B: $150,000 ÷ $1,000,000 = 0.15, and 1.4 × 0.15 = 0.21. Step 3 — ratio C: $80,000 ÷ $1,000,000 = 0.08, and 3.3 × 0.08 = 0.26 (0.264 unrounded). Step 4 — ratio D: $500,000 ÷ $500,000 = 1.00, and 0.6 × 1.00 = 0.60. Step 5 — ratio E: $900,000 ÷ $1,000,000 = 0.90, and 1.0 × 0.90 = 0.90. Step 6 — the Z-score: 0.12 + 0.21 + 0.26 + 0.60 + 0.90 = 2.09 (unrounded 2.0940000). Step 7 — the zone: 2.09 sits between 1.81 and 2.99, so the zone is grey. Work it yourself in the Altman Z-score calculator.

What the number means

A Z-score above 2.99 is safe, 1.81 to 2.99 is grey, and below 1.81 is distress — and the zones are strict: exactly 2.99 is grey, not safe, and exactly 1.81 is grey, not distress. A safe score means the five factors together look like the healthy companies in Altman’s study. A grey score means the factors do not clear the safe line. A distress score means the model’s bankrupt group looked like this. None of the three is a prediction: a safe company can still fail if its cash runs out, and a distressed company can still recover if its earnings turn.

What moves the score

EBIT moves it fastest, because it carries the heaviest weight: every extra dollar of EBIT adds 3.3 ÷ total assets to the score, so on $1,000,000 of assets each $100,000 of EBIT is worth 0.33. Sales move it next: every extra dollar of sales adds 1.0 ÷ total assets, so each $100,000 of sales is worth 0.10. Liabilities move it the other way, and not in a straight line: the market-value ratio is market value divided by liabilities, so doubling the debts halves the ratio. Working capital and retained earnings move it slowest, at weights 1.2 and 1.4, but they are the cushion: a company that has kept its profits and can pay its short-term bills buys time.

Altman Z-score vs the single ratios

The working-capital calculator measures working capital alone — current assets minus current liabilities — which is only one input to the Z-score. Work it out in the working capital calculator, or read the guide to working capital. The current-ratio calculator divides current assets by current liabilities — a liquidity snapshot, not a multi-factor distress score — and the quick-ratio calculator is the same: one ratio. The fixed-charge-coverage calculator measures coverage of fixed charges by earnings, not a five-factor score, and the free-cash-flow calculator measures cash flow, not distress prediction. Each single ratio answers one question; the Z-score answers whether the five answers together look like a healthy company or a distressed one.

The snapshot caveat: what the score assumes

The Z-score is a snapshot, not a forecast. It was built on public manufacturing companies in 1968 — service companies, banks and insurers have different balance sheets, so treat the score as a screen, not a verdict. Private companies have no market value of equity, so they need a different Z-score variant. And the score says nothing about cash in the bank, fraud, or management.

Traps to avoid

First, the undefined cases. If total assets are zero, every ratio divides by total assets — division by zero — and the Z-score is undefined. If total liabilities are zero, the market-value ratio divides by total liabilities — division by zero — and the Z-score is undefined. The calculator shows “undefined” with a note in both cases, never a number, never hidden.

Second, the negatives. Negative working capital means current liabilities exceed current assets: at −$50,000 of working capital the Z-score is 1.91 — grey — because the working-capital contribution goes negative and drags the score down. Negative EBIT means the company is losing money: at −$100,000 of EBIT the Z-score is 1.50 — distress — because the earnings contribution goes negative. The calculator shows both figures with notes, never hides them.

Third, the rounding. The Z-score is displayed to two decimals, half-up. At $351,515 of EBIT the unrounded Z-score is 2.9899995 — it displays as 2.99 but the zone is grey, because 2.9899995 is below 2.99. One dollar more of EBIT clears the line. At $615,999 of sales the unrounded Z-score is 1.8099990 — it displays as 1.81 but the zone is distress. One dollar more of sales puts the score exactly on the line — grey, not distress.

Frequently asked questions