ALTMAN ZSCORE Meaning and
Definition
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The Altman Z-Score is a formula used to assess the financial health and creditworthiness of a company. Developed by Edward I. Altman, an American finance professor, in the late 1960s, the Altman Z-Score is primarily used to predict the likelihood that a company will go bankrupt within the next two years.
The formula utilizes multiple financial ratios to generate a single numerical score, which is then interpreted to determine the company's financial standing. The ratios include profitability, liquidity, leverage, solvency, and other key financial metrics. These ratios are calculated based on the company's financial statements, including its income statement, balance sheet, and cash flow statement.
The resulting score is categorized into three zones: a safe zone, a gray zone, and a distress zone. Companies scoring in the safe zone are considered financially healthy and are less likely to face bankruptcy. On the other hand, companies scoring in the distress zone indicate a high probability of bankruptcy. The gray zone represents a more ambiguous financial position, with a level of uncertainty regarding the company's viability.
The Altman Z-Score has become a widely recognized and widely used tool by investors, lenders, and financial analysts to assess credit risk and make informed decisions. As with any financial modeling tool, it has its limitations and should not be the sole basis for making investment or lending decisions. However, it provides a valuable quantitative assessment of a company's financial health and bankruptcy risk.
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Etymology of ALTMAN ZSCORE
The term "Altman Z-Score" is not derived from an etymology but rather from the name of its creator, Edward I. Altman, an American economist and professor.
In 1968, Altman developed the Altman Z-Score, a formula used to predict the likelihood of bankruptcy for publicly traded companies. The Z-Score combines multiple financial ratios into a single score to assess a company's financial health and probability of insolvency. It has become a popular tool in financial analysis and is widely used around the world.
The "Z" in Altman Z-Score refers to the standard normal distribution, also known as the Z-distribution, which has a mean of zero and a standard deviation of one. The Z-Score is designed to calculate the distance of a company's financial ratios from the mean, indicating the relative risk of bankruptcy.
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