What is the Altman Z-score formula and how do I interpret it for manufacturers?

Question

AcadiFi · Accepted Answer

The original 1968 Altman Z-score for public manufacturers is Z = 1.2 X1 + 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5, where X1 is working capital to total assets, X2 is retained earnings to total assets, X3 is EBIT to total assets, X4 is market value of equity to book value of total liabilities, and X5 is sales to total assets.

Worked example: suppose Kettleridge Tool & Die reports working capital of $18M, retained earnings of $42M, EBIT of $15M, total assets of $180M, market cap of $120M, total liabilities of $90M, and sales of $220M. Then X1 = 0.10, X2 = 0.233, X3 = 0.0833, X4 = 1.333, X5 = 1.222. Z = 0.12 + 0.326 + 0.275 + 0.80 + 1.222 = 2.74. This falls in the grey zone.

Interpretation bands: Z > 2.99 is the safe zone, 1.81 < Z < 2.99 is the grey zone, and Z < 1.81 is the distress zone with high bankruptcy probability within two years. For private manufacturers use the Z' variant (coefficients 0.717, 0.847, 3.107, 0.420, 0.998 with book value of equity in X4, cutoffs 2.90 and 1.23). For non-manufacturers and emerging markets use Z'' which drops X5 entirely. On the FRM exam, a common trap is applying the original coefficients to a private firm — always verify which Z variant matches the obligor profile.

What is the Altman Z-score formula and how do I interpret it for manufacturers?

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