Altman Z-Score

The Altman Z-Score, developed by Edward Altman in 1968, blends five ratios — working capital, retained earnings, and EBIT each scaled to total assets, equity scaled to liabilities, and asset turnover — into one number that has proven remarkably durable at flagging bankruptcy risk one to two years out. In the original public-company model, scores above 2.99 sit in the safe zone, 1.81 to 2.99 in the grey zone, and below 1.81 in the distress zone.

Several variants matter in practice. The Z'-Score adapts the model for private manufacturers (using book equity instead of market value, with distress below 1.23), and the Z"-Score drops asset turnover for non-manufacturers and service firms (distress below 1.1). Using the right variant matters: applying the public-company formula to a private subcontractor will mislead. The model also assumes reasonably honest financials — it cannot see fraud, and it is weakest for very small companies and financial-services firms.

In a credit department, the Z-Score works best as a screening and trend tool rather than a verdict. A customer whose score drifts from 3.1 to 2.2 to 1.6 across three statement cycles deserves a manual review, a fresh bureau pull, and possibly a limit reduction — even if each individual ratio still looks tolerable. Its power is aggregation: it catches gradual, multi-front deterioration that any single ratio can hide.