Glossary · underwriting

Altman Z-Score

Also called Z-score, Altman Z, bankruptcy prediction score.

A five-ratio model built in the 1960s to predict corporate bankruptcy, still used as a screening statistic, and calibrated on public manufacturers rather than on private small businesses.

Drafted with AI assistance. Not yet independently checked. Nobody has verified the claims on this page against a source, so treat the figures and legal points as a starting point rather than as settled, and confirm anything you are about to act on. How we check things.

What it means

A weighted sum of five balance-sheet and income-statement ratios, producing one number placed in a zone.

The original model

Z = 1.2·X1 + 1.4·X2 + 3.3·X3 + 0.6·X4 + 1.0·X5, where

  • X1 working capital ÷ total assets
  • X2 retained earnings ÷ total assets
  • X3 earnings before interest and tax ÷ total assets
  • X4 market value of equity ÷ book value of total liabilities
  • X5 sales ÷ total assets

Published zones: above 2.99 is the safe zone, 1.81 to 2.99 is grey, below 1.81 is distress.

The variants

The original was fitted on publicly traded manufacturers, so two adaptations followed and both change the arithmetic, not just the inputs.

Private firms (Z').Book value of equity replaces market value in X4, and the coefficients are refitted: 0.717, 0.847, 3.107, 0.420 and 0.998, with a safe zone above 2.9 and distress below 1.23.
Non-manufacturers (Z'').X5, the asset turnover term, is dropped entirely, and the coefficients become 6.56, 3.26, 6.72 and 1.05, with a safe zone above 2.6 and distress below 1.1.

Different sources state these slightly differently and the model has been revised over decades. If a number is being quoted at you, ask which variant produced it.

Where you would meet it

Rarely quoted directly to a small business. It sits inside some commercial scoring products, some trade credit insurers' models, and inside "check your business's financial health" tools attached to accounting software.

Where this one catches people

A low score on a small private service business usually means the model does not fit, not that the business is failing, and there are three structural reasons.

Retained earnings. An owner who distributes profit annually for tax reasons carries little or no retained earnings, so X2 — the second-heaviest term in the private variant — is near zero or negative regardless of how the business trades.

Asset intensity. X5 is sales over total assets, so an asset-light business scores oddly, and X3 divides earnings by a small asset base in a way the original manufacturing sample never contemplated.

Market value. There is none, which is why the private variant exists, and why quoting the original formula at a private company is simply wrong.

Treat any distress score shown to you as a prompt for a question, not a conclusion: which variant, what inputs, from which financial statements, and as at what date. That matters most when the score arrives attached to an offer of expensive money.

Worked through

Illustrative only, using the private-firm variant.

Total assets $1,200,000. Working capital $180,000, so X1 = 0.150. Retained earnings $240,000, so X2 = 0.200. EBIT $150,000, so X3 = 0.125. Book equity $400,000 against total liabilities $800,000, so X4 = 0.500. Sales $2,400,000, so X5 = 2.000.

Z' = 0.717(0.150) + 0.847(0.200) + 3.107(0.125) + 0.420(0.500) + 0.998(2.000)

= 0.108 + 0.169 + 0.388 + 0.210 + 1.996 = 2.87.

That sits just under the 2.9 threshold — the grey zone, not distress.

Now suppose the same owner had distributed profits every year instead of retaining them, so retained earnings are zero. The X2 term contributes nothing and the score falls to 2.70. Same trading, same cash, same customers. The number moved because of a tax decision.

Figures in the example are illustrative. They show the arithmetic, not a quote — what any one lender would charge is on that lender's page, where it is published at all.

Where you will meet this term

Term Loan Business Line of Credit

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Altman Z-Score — common questions

What does altman z-score mean?

A five-ratio model built in the 1960s to predict corporate bankruptcy, still used as a screening statistic, and calibrated on public manufacturers rather than on private small businesses.

Where does altman z-score catch people out?

A low score on a small private service business usually means the model does not fit, not that the business is failing, and there are three structural reasons.

Is altman z-score the same as an interest rate?

Altman Z-Score is defined above; if you are comparing it against a rate, check whether the two measures share a time dimension before you put them side by side.

Which products does altman z-score apply to?

Term Loan, Business Line of Credit.

Is there a worked example of altman z-score?

Yes, on this page, and it is labelled illustrative. It shows the arithmetic, not a quote from any lender.

What else should I read alongside altman z-score?

Automated underwriting, Business credit score, Credit Insurance, Current ratio, EBITDA.

Has this definition been checked?

Not yet. This entry is drafted and live, and the notice at the top says so. Confirm anything you are about to act on.

Is this legal advice?

No. It is a definition. What a clause does in your contract, in your state, is a question for a lawyer licensed where you are.

Can I suggest a term?

Yes — [email protected]. The glossary grows from what people are actually shown in contracts.