Predicting Bankruptcy 
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ZScore 
Summary of Altman's Zscore Model. Abstract 
Edward I. Altman, 1968 
Altman's Model for Predicting Bankruptcy
is a multivariate formula for a measurement
of the financial health of a company and a powerful diagnostic tool that
forecasts the probability of a company entering bankruptcy within a 2
year period. Studies measuring the effectiveness of the ZScore
have shown the model is often accurate in predicting bankruptcy (72%80%
reliability)
ZS was developed in 1968 by
Dr. Edward I. Altman, Ph.D., a financial economist and professor at
New York University's Stern School of Business. The ZS bankruptcy predictor combines five common business ratios, using a weighting system calculated by Altman to determine the likelihood of a company going bankrupt. It was derived based on data from manufacturing firms, but has since proven to be effective as well (with some modifications) in determining the risk a service firm will go bankrupt. How should the results be judged? It depends:  Original ZSCORE [For Public Manufacturer] If the score is 3.0 or above  bankruptcy is not likely. If the Score is 1.8 or less  bankruptcy is likely. A score between 1.8 and 3.0 is the gray area. Probabilities of bankruptcy within the above ranges are 95% for one year and 70% within two years. Obviously, a higher score is desirable.
For the ZS Formula, see the figure on the right. Note the variations for public and private companies. Book: John B. Caouette, Edward I. Altman, Paul Narayanan  Managing Credit Risk  Compare ZScore to these liquidity measurement ratios: Current Ratio  Quick Ratio  Cash Ratio  RAROC 
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