Z-Score distress prediction model

Z-Score description

The Z-Score is the most thoroughly tested and broadly accepted distress prediction model.

As such it is arguably the most important tool used in turnaround management for diagnosing and evaluating overall financial corporate health, as well as the viability of turnaround or restructuring efforts.

As a reliable test of corporate financial health, it is widely used by courts of law, and the banking, credit risk management and turnaround industries in the USA as a benchmark for credit status and corporate health. 

There are more sophisticated models available, but they are proprietary and not freely available (see the box on the right).

Z-Score origin

The Z-Score was developed by Professor Edward I. Altman of the Stern School of Business at New York State University. 

He is an active participant in the Turnaround Management Association - Southern Africa and chairs the association's Academic Advisory Council.

Z-Score use

The Z-Score applies statistical techniques (Multiple Discriminant Analysis) to financial ratios to determine the overall health status of a business:

  • Healthy Zone: Business is in good shape.
  • Danger Zone (zone of ignorance, zone of uncertainty): Warning signals, exercise caution.
  • Failing Zone: High likelihood of bankruptcy within one year.

How we use the Z-Score

At CRS Turnaround we apply the Z-Score to determine:

  • The degree of distress of a troubled company i.e. is it in danger or failing.
  • The Z-Score trend i.e. is the company heading towards the Danger Zone or Failing Zone, and how fast.
  • The impact of a turnaround plan - will it be possible to get out of the Danger/Failing Zone, and how soon (see quantitative turnaround viability assessment for a real-life example).

If you wish to obtain your own company's Z-Score, you can make use of our free Financial Health Diagnosis service.


Z-Score users in the USA

  • Turnaround management:  To develop emergency action plans and turnaround strategies to quickly correct a deteriorating situation.
  • Corporate Governance:  Board of Directors and Audit Committee analysis of going concern capability, consideration of corporate risk, and analysis of merger and acquisition scenarios.
  • Credit Evaluation:  Loan officers and credit managers in accepting or rejecting loan applications.
  • Private Investment:  Private equity, stockbrokers and individual investors to evaluate the relative safety of a proposed investment.
  • M & A Analysis:  To consider an entity's viability both before and after a corporate reorganisation.
  • Insurance Underwriting:  To evaluate the potential credit risk of the proposed insured including risk sharing and self-insured retentions.
  • Courts of law: e.g. Chapter 11 hearings.

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Other credit rating systems

Commercial systems are available in the SA market place:

  • Moody's Risk Calc
  • Standard & Poors
  • KMV
  • Creditmetrics

 

 

The Z-Score is a useful tool for recognising the need for a turnaround, determining the degree of financial distress, and to see gauge whether a turnaround plan will be feasible.