The Altman Z-Score
The Altman Z-score is a single number, built from five accounting ratios, that was one of the first models to predict corporate bankruptcy from financial statements alone.
In 1968, Edward Altman asked whether a handful of standard accounting ratios, combined the right way, could tell you a company was headed for bankruptcy before it happened. The answer he found is the Z-score: a weighted sum of five ratios covering liquidity, retained profitability, operating profitability, market leverage, and sales efficiency, each capturing a different way a company can be quietly deteriorating.
In words: working capital relative to assets, retained earnings relative to assets, operating earnings relative to assets, market value of equity relative to total liabilities, and sales relative to assets, each scaled by a weight Altman fit statistically so the combination best separated companies that went bankrupt from those that didn't.
A single ratio can look fine while a company is still failing — the Z-score's value is in combining five different angles on solvency into one number, with cutoffs (below 1.8 distress, above 3.0 safe, in between a "grey zone") that flag risk earlier than any one ratio would alone.
Worked example. A manufacturer has working capital/assets of 0.15, retained earnings/assets of 0.10, EBIT/assets of 0.05, market equity/liabilities of 0.80, and sales/assets of 1.20. The score is . That falls in the "grey zone" between 1.8 and 3.0 — not clearly safe, not clearly distressed, and worth watching rather than dismissing or panicking over.
The model was built on manufacturing firms and dated leverage assumptions, so modern desks treat it as one screening signal among many rather than a standalone verdict.
Practice in interviews
Further reading
- Altman, 'Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy' (1968)