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Fiscal Fitness of Your Company: The Z-Score

Posted Wednesday, March 18, 2015 by Stuart Margolis, CPA, MT Margolis Partners LLC.

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Recently, a lending institution asked a company owner for the company’s “Z-Score”. Perplexed by the request, the owner called us for a calculation. Here is scoop on the Z-Score.

The Z-Score was developed in the 1960’s by Edward I. Altman, a business professor at New York University. Dr. Altman researched many companies that had gone bankrupt, and others that were thriving. He eventually focused on five key financial ratios as determinants of financial success. He assigned a weight to each of the five, multiplying each ratio by a weighted number to indicate the relative importance he derived through research and practice. The sum of the weighted ratios is the Z-Score. Like many other ratios, the Z-Score is an indicator that can be used to see how your company is doing on its own, and how it compares to others in your industry. It is common for banks and investors to use the Z-Score to determine fiscal fitness.

The Z-Score takes into account 8 variables from a company’s financial statements:

alt textThe 8 variables are used to comprise the following 5 Ratios. The chart below also shows the weight assigned to each Ratio in determination of Z-Score.

alt text

To derive your Z-Score the calculation is:

Z Score =EBIT/Total Assets(3.3) + Net Sales/Total Assets (0.99) + Market Value of Equity/Total Liabilities (0.6) + Working Capital/Total Assets (1.2) + Retained Earnings/Total Assets (1.4)

Our Example firm created the follow Z-Score:

alt text

Interpretation of Z-Score:alt text

Our example firm resulted in a factor of 1.87 and fell into the “Could be a chance of the company heading towards bankruptcy within 2 years of operations from the date of financial figures given.” In reality, they fell towards the bottom range of this category. This particular company was sold, instead of moving into bankruptcy, almost 2 years after these results received!

In recent years, we’ve helped companies with less than favorable Z-Scores turn around and thrive. If you are in trouble call and get help.

About Margolis Partners

Margolis Partners have long been recognized as the financial experts for privately-held businesses with a specialty in print and packaging, assisting companies with strategic and financial management, valuation, mergers/acquisitions, accounting, audit and tax services. The firm is noted for its expertise in enabling companies to optimize profits. Proudly, it is the purveyor of the industry’s Value-Added Principles of Management, and compiles the annual Printing Industries of America Ratios, the printing industry’s premier financial benchmarking tool.