Skip to content

Strategic Performance Management and Business Valuation · Corporate Failure

Altman Z-Score Model for Predicting Corporate Failure

Updated 11 October 2026 · Fact-checked

The Altman Z-score is a single number built from five financial ratios, each multiplied by a fixed weight, to predict the chance of bankruptcy. For the original public manufacturing model, Z above 2.99 is safe, 1.81 to 2.99 is grey, and below 1.81 is distress. Calculate the five ratios, apply the weights, add, then classify.

Understand Predicting Failure: Altman Z-Score Model

Corporate failure rarely happens overnight. Weak profits, falling liquidity and heavy debt show up in the accounts first. Edward Altman combined several ratios into one score so that you can judge failure risk with a single number instead of reading each ratio separately.

The method is called multiple discriminant analysis. Altman studied manufacturing firms that went bankrupt and firms that survived. He found the five ratios that best separated the two groups and gave each a weight. Ratios that separate the groups strongly get higher weights. That is why EBIT to total assets carries the biggest weight (3.3 in the original model) and sales to total assets a small one (1.0).

The five ratios cover different sides of health. Working capital to total assets shows liquidity. Retained earnings to total assets shows accumulated profitability and the firm's age. EBIT to total assets shows the earning power of assets. Market value of equity to total liabilities shows how much the equity cushion can fall before debt exceeds assets. Sales to total assets shows asset efficiency.

A higher Z means lower failure risk. The score is placed in a zone: safe, grey or distress. The grey zone means the model cannot clearly say. The firm needs closer study, not a firm verdict.

There are three versions. The original (1968) is for listed manufacturing firms. Z′ is for private manufacturing firms and uses book value of equity. Z″ is for non-manufacturing and emerging-market firms and drops the sales to assets ratio. In exams, always check which kind of firm the question describes before choosing the formula.

Key rules to remember

Original Z-score (public manufacturing firms)
Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5
Use for listed manufacturing companies. Some books write the weights as decimals (0.012, 0.014, 0.033, 0.006, 0.999) with ratios in percentages; use the form the question gives.
Variables X1 to X5
X1 = Working capital ÷ Total assets; X2 = Retained earnings ÷ Total assets; X3 = EBIT ÷ Total assets; X4 = Market value of equity ÷ Total liabilities; X5 = Sales ÷ Total assets
Working capital = current assets − current liabilities. Total liabilities means book value of all debt and liabilities.
Zones for original model
Z > 2.99: safe; 1.81 ≤ Z ≤ 2.99: grey; Z < 1.81: distress
Some texts use 1.8 and 3.0 as rounded cut-offs. Use what the question states.
Z′-score (private manufacturing firms)
Z′ = 0.717 X1 + 0.847 X2 + 3.107 X3 + 0.420 X4 + 0.998 X5
X4 uses book value of equity ÷ total liabilities. Zones: Z′ > 2.9 safe; 1.23 to 2.9 grey; Z′ < 1.23 distress.
Z″-score (non-manufacturing and emerging markets)
Z″ = 6.56 X1 + 3.26 X2 + 6.72 X3 + 1.05 X4
No sales ratio, so it removes industry effects of asset turnover. X4 uses book value of equity. Zones: Z″ > 2.6 safe; 1.1 to 2.6 grey; Z″ < 1.1 distress.

How to solve Predicting Failure: Altman Z-Score Model questions

Use this method for any Altman Z-score question, whether it asks for the score, the zone or a comment.

  1. 1Identify the type of firm: listed manufacturer, private manufacturer, or non-manufacturing. This decides the formula and cut-offs.
  2. 2List the data: current assets, current liabilities, retained earnings, EBIT, equity value, total liabilities, sales and total assets.
  3. 3Compute working capital as current assets minus current liabilities. Note if the question gives it directly.
  4. 4Calculate X1 to X5 as decimals. Keep three or four decimal places.
  5. 5Multiply each ratio by its weight and add the products to get Z.
  6. 6Compare Z with the cut-offs and name the zone.
  7. 7Write a short comment: which ratio is weakest or strongest, what the zone means, and what management should do. Mention that the model is a screening tool, not a certainty.

Quickest way: Weights table and one-line total

When to use it: Use when the question gives clean figures and asks only for the Z-score and zone.

  1. Write the five weights in a row: 1.2, 1.4, 3.3, 0.6, 1.0.
  2. Divide every balance item by total assets once, except equity value, which is divided by total liabilities.
  3. Multiply and add in one line: Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 1.0(X5).
  4. Compare with 1.81 and 2.99 and write the zone at once.
  5. Spend remaining time on a two-line interpretation, since marks are given for it.

Common mistakes in Predicting Failure: Altman Z-Score Model

  • Dividing market value of equity by total assets for X4.

    All other ratios use total assets, so students assume X4 does too.

    Fix: Remember X4 is equity value ÷ total liabilities. Underline 'liabilities' when you list the formula.

  • Using the wrong version for a private or service company.

    Students memorise only the original formula.

    Fix: Read the firm description first. Private manufacturer: Z′ with book equity. Service or non-manufacturing: Z″ without sales.

  • Using EBIT as profit after tax or net profit.

    The question may give several profit figures.

    Fix: X3 uses earnings before interest and tax. Pick that figure, not PAT or PBT.

  • Computing working capital with total current assets only.

    Students forget to subtract current liabilities.

    Fix: Working capital = current assets − current liabilities. It can be negative, which lowers Z.

  • Calling a grey-zone firm bankrupt, or a safe firm risk-free.

    Students treat the zones as certain verdicts.

    Fix: State that grey means uncertain and needs further analysis, and that the model is a predictor based on past data, not a guarantee.

  • Mixing percentage weights with decimal ratios.

    Some texts show 0.012 weights with ratios in percent.

    Fix: Use 1.2 with ratios as decimals, or 0.012 with ratios as percentages. Never mix them.

Worked examples

Example 1

A listed manufacturing company, Bharat Steelworks Ltd, has the following figures (₹ crore): current assets 400, current liabilities 250, retained earnings 300, EBIT 180, market value of equity 900, total liabilities 600, sales 1,500, total assets 1,000. Calculate the Altman Z-score and state the zone.

Show the solution
  1. Working capital = 400 − 250 = ₹150 crore.
  2. X1 = 150 ÷ 1,000 = 0.15.
  3. X2 = 300 ÷ 1,000 = 0.30.
  4. X3 = 180 ÷ 1,000 = 0.18.
  5. X4 = 900 ÷ 600 = 1.50.
  6. X5 = 1,500 ÷ 1,000 = 1.50.
  7. Z = 1.2(0.15) + 1.4(0.30) + 3.3(0.18) + 0.6(1.50) + 1.0(1.50).
  8. Z = 0.18 + 0.42 + 0.594 + 0.90 + 1.50 = 3.594.
  9. 3.594 is above 2.99, so the firm is in the safe zone.

Answer: Z = 3.594 (about 3.59). The company is in the safe zone, so the model sees a low chance of bankruptcy.

Example 2

Sundaram Fabrics Ltd is a listed manufacturer with total assets of ₹800 lakh, total liabilities ₹560 lakh, working capital ₹40 lakh, retained earnings ₹80 lakh, EBIT ₹64 lakh, market value of equity ₹224 lakh and sales ₹720 lakh. Compute Z, classify the firm and comment.

Show the solution
  1. X1 = 40 ÷ 800 = 0.05.
  2. X2 = 80 ÷ 800 = 0.10.
  3. X3 = 64 ÷ 800 = 0.08.
  4. X4 = 224 ÷ 560 = 0.40.
  5. X5 = 720 ÷ 800 = 0.90.
  6. Z = 1.2(0.05) + 1.4(0.10) + 3.3(0.08) + 0.6(0.40) + 1.0(0.90).
  7. Z = 0.06 + 0.14 + 0.264 + 0.24 + 0.90 = 1.604.
  8. 1.604 is below 1.81, so the firm is in the distress zone.
  9. Comment: working capital, retained earnings and EBIT returns are all low relative to assets, and the equity cushion is thin against liabilities. Only asset turnover is reasonable.

Answer: Z = 1.604, which is in the distress zone (below 1.81). The firm has a high risk of failure unless it improves profitability, liquidity and its debt position. Management should urgently review costs, working capital and leverage.

Exam tips

  • Write the correct formula with weights before calculating. Marks are often given for the formula and for each ratio.
  • Show each of X1 to X5 separately. A wrong final answer can still earn most marks if the method is clear.
  • Always add a zone and a two-line comment. Questions often say 'comment on the financial health'.
  • In MCQs, check for traps: which firm type, equity at market or book value, and whether working capital is already given.
  • Note the limits of the model if asked: built on US manufacturing data, uses historical accounts, and does not capture qualitative factors.

Practice questions from Corporate Failure

Predicting Failure: Altman Z-Score Model in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Predicting Failure: Altman Z-Score Model: frequently asked questions

What is the Altman Z-score formula for CMA Final?

The original formula is Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5. The five ratios are working capital, retained earnings and EBIT, each to total assets, market value of equity to total liabilities, and sales to total assets.

What are the safe, grey and distress zones?

In the original model, Z above 2.99 is safe, 1.81 to 2.99 is grey, and below 1.81 is distress. A grey score means the result is uncertain and needs further analysis.

Which Z-score do I use for a private or service company?

For a private manufacturing firm use Z′, which uses book value of equity. For non-manufacturing or emerging-market firms use Z″, which drops the sales to total assets ratio.

Does a low Z-score mean the company will definitely fail?

No. It shows a high statistical risk based on past data. Firms in distress can recover through turnaround action, and the model ignores qualitative factors such as management quality.