Z-score: A quantitative approach to predicting business failure

In the late 1960s, Edward Altaman, a professor from NYU introduced a model to quantitatively measure the financial health of a company. Instead of using a single ratio, the Z-score combines multiple areas which shall be seen below.

Z = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

Where:

A = Working capital / total assets

B = Retained earnings / total assets 

C = Earnings before interest and tax (EBIT) / total assets 

D = Market value of equity / book value of total debt 

E =  Sales / total assets 

The model suggests that a score of 3.0 and above indicates that the company is financially sound. At the other end of the spectrum, a score of 1.8 or less is an sign that the company is likely to head into bankruptcy soon. 

The grey area, 1.8 to 3.0 is where the uncertainly lies. Other methods of analysis, especially qualitative models should be used to get a better picture. 

Head over to Investopedia for a more detailed explanation of this. 

Example: High-5 Conglomerate Bhd 
Let us inspect further a counter that was suspended on 14th August and subsequently delisted on 10th September.

The values used for this example were taken from the 2013 annual report. 

A = (16 226 - 275 361) / 100 966
= - 2.5666

B = - 425 059 / 100 966
= -4.209

C = - 35 319 / 100 966
= - 0.3498

D = - 174 395 / 345 356
= - 0.5949

E = 78 944 / 100 966
= 0.7819

Inserting these values into the equation gives a Z score of - 9.7019.

Thus it can be seen here that a quantitative approach alone was enough to conclude that High-5 Conglomerate Bhd is in a bad shape. (Of course, there are qualitative aspects as well)