Modified Altman Z' Score
- Distress: high risk of bankruptcy
- Gray: neither safe nor distressed
- Safe: low risk of bankruptcy
The Altman Z-Score is a financial stability metric that combines several ratios to predict the likelihood of a company going bankrupt. Since the original model was built for manufacturing companies, the Altman Z' Score is a revised version of the Altman Z-Score that is a better fit for non-manufacturing companies.
The problem with the original Prime Z-Score was that book value was used to determine the 4th parameter (Book Value of Equity / Total Liabilities). This is a problem for SaaS/Cloud companies because most of their assets consist of intellectual property. Accounting rules can also bloat this figure if a company grows by acquisitions, resulting in a large amount of goodwill appearing on the balance sheet.
Since we favor companies that grow organically, we use market value instead to avoid this distortion. Our own modified version of the Altman Z' Score is as follows:
Z' = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4
where:
- X1 = Working Capital / Total Assets
- X2 = Retained Earnings / Total Assets
- X3 = Earnings Before Interest and Taxes / Total Assets
- X4 = Market Value of Equity / Total Liabilities