How to Predict Bankruptcy

The Z-score formula was developed by Edward Altman, Assistant Professor of Finance at New York University. The score predicts bankruptcy two years prior to its occurrence. The Z-score concept was first published in 1968. The score tries to predict the probability of default by companies due to financial distress. It is based on the current financial statistics of the company. Z- score statistics of BSE 500 companies ZoneRangeAvg 3Y return (%)No. of companiesFY10      FY15Distress zoneLess than 1.816.512473Grey zone1.8 to 2.9923.777765Safe zoneMore than 327.71197160 The formula for the Z-score is: Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + 1T5 Where: T1 is working capital divided by total assets (measures liquid assets in relation to the size of the company). T2 is retained earnings divided by total assets (measures profitability that reflects the company's age and earning power). T3 is earnings before interest and taxes divided by total assets (measures operating efficiency apart from tax and leveraging factors. It recognises operating earnings as being important to long-term viability). T4 is market value of equity divided by book value of total liabilities (adds market dimension that can show up security price fluctuation as a possible red flag). T5 is sales divided by total assets (standard measure for total asset turnover). When Z > 2.99, the company is considered in the 'safe' zone. 1.81 < Z < 2.99, the company is considered in the 'grey' zone.