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Altman Z-Score

  • Writer: BalancingAF
    BalancingAF
  • Jun 3, 2020
  • 2 min read

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A model developed in 1968 by an American professor- Edward Altman. It emphasizes on measuring the financial stability of a Company by assessing whether the entity is going to face bankruptcy in the Next Two Years or not. It has proven to be a useful tool for evaluating performances during the 2008 Financial Crisis, especially for public manufacturing companies.


The formula of Altman Z-Score is:

= 1.2A + 1.4B + 3.3C + 0.6D + 1.0E


A: Working Capital / Total Assets

  • Working capital- The money needed by the company to meet its routine day to day activities. Formula= Current Assets - Current Liabilities.

  • Total Assets- Formula= Non-Current Assets + Current Assets

  • The ratio compares the net liquid assets of the company to its total assets

B: Retained Earnings / Total Assets

  • Retained Earnings- The profits ploughed back by the company after paying dividends to the shareholders. Higher the retained earnings, lesser are the odds of it going bankrupt as they have enough cash with them to meet the current obligations.

  • The ratio measures the extent to which the company relies on debt.

C: Earnings before Interest and Tax / Total Assets

  • Earnings before Interest and Tax (EBIT): It is the operating profit of the company before paying out non-operating expenses like Interest and Tax.

  • The ratio shows how effectively the company is using its Assets

D: Market Capitalization / Total Liabilities

  • Market Capitalization- The market value of the company traded on the stock exchange multiplied by the total number of shares outstanding.

  • Total Liabilities- Formula= Non-current liabilities + Current Liabilities.

  • The ratio shows how much the firm’s assets can decline before the liabilities exceed the assets.

E: Sales / Total Assets

  • Sales- The total revenue earned by the company.

  • The ratio calculates the Asset turnover of the company


How to interpret the Result?

If the score is -

  • Less than 1.8- Distress Zone- Implies, a very high chance of bankruptcy.

  • Between 1.8 and 3- Grey Zone. Implies a moderate chance of bankruptcy.

  • More than 3- Safe zone- Less chance of bankruptcy.


Case Study- Suzlon Energy Ltd.


Overview:

Suzlon Energy Ltd. was founded by Tulsi R. Tanti in 1995 who’s the Chairman and Managing Director. It is primarily engaged in the business of manufacturing of Wind Turbine Generators and related components of various capacities. Its presence is in 18 countries across Asia, Australia, Europe, Africa and America.

The company reported Revenues of Rs666Cr in Q3FY20 (Revenue Q3FY19- Rs1097Cr) and a Net-Loss of Rs736Cr (Net Loss Q3FY19- Rs38Cr)


Calculation of Altman-Z-Score for Suzlon:

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Conclusion:

The Altman Z-Score for Suzlon is -1.56 and hence falls in the Distress Zone and the formula suggests bankruptcy in the near future.

However, as a rational investor, you should always look into ALL the factors while analysing a company. In the case of Suzlon, the factors include- Demand for Renewable sources of energy in the future, Managements say on revival plans, Cash flows, etc. Hence, a conclusion should never be obtained on the basis of just applying the Altman Z-Score.

Write-up by: Muskan Aswani

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