Modified Altman Z score

Altman’s original five-ratio model (see Altman Z-score) was designed for manufacturers, or sectors with high capital intensity, such as mining.

The problem is it uses the sales/total assets ratio, which can skew the result in sectors that are not capital intensive. A low total assets figure brings this ratio, and the resulting Z score, down too far and can generate a number that suggests financial distress when there may be none. Low capital intensity sectors include many service sector firms where people, rather than physical assets, are the main source of added value.

A modification to the Z score removes this ratio altogether to leave the remaining four, then re-weights them, still giving the most importance to the first: EBIT to total assets, followed by working capital to total assets, retained earnings to total assets and market capitalisation to total liabilities. It is interpreted similarly to the original Z score. A result of 2.6 or higher is ‘safe’; a score of one or less suggests big trouble.

 

MoneyWeek magazine

Latest issue:

Magazine cover
A new lease of life?

The drugs transforming old age

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 4 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

FREE REPORT:
What you should really do with your money (2014 Edition)


How to buy and sell penny shares

A beginner's guide to investing in gold

How to invest in British fracking