PREPARED BY :SHIKHA KALANISUCHIKA A DHANDHARIAPRACHI MORELAKHYA JYOTI BORAHAAMID SIDDIQUEDEEP KOIRI

There have been an increasing number of bankruptcies. Will a company go bankrupt?Will your major customers or suppliers go bankrupt? What warning singns exist and what can be done to avoid corporate failure ???????????

Altman’s Z--Score formula is a multivariate formula used to measure the financial health of a company and to diagnose the probability that a company will go bankrupt within a two-year period.

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

Altman’s Z score is one of the best known, statistically derived predictive models used to forecast a firm’s impending bankruptcy .

what is Z-score??

The Z-Score formula for predicting bankruptcy was published in 1968 by Edward Altman , who was at the time, an Assistant Professor of Finance at New York University.

The original research was based on data from publicly held manufacturers (66 firms, half of which had filed for bankruptcy). Altman calculated 22 common financial ratios for all of them and then used multiple discriminant analysis to choose a small number of those ratios that could best distinguish between a bankrupt firm and a healthy one. To test the model, Altman then calculated the Z-Scores for new groups of bankrupt and non bankrupt but sick firms (i.e. with reported deficits) in order to discover how well the Z-Score model could distinguish between sick firms and the terminally ill.

HISTORY

Does the Altman Z-Score Work?

In its initial test, the Altman Z-Score was found to be 72% accurate in predicting bankruptcy two years prior to the event. In subsequent tests over 31 years up until 1999, the model was found to be 80-90% accurate in predicting bankruptcy one year prior to the event.

In 2009, Morgan Stanley strategy analyst, Graham Secker, used the Z-score to rank a basket of European companies. He found that the companies with weaker balance sheets underperformed the market more than two thirds of the time. Morgan Stanley also found that a company with an Altman Z-score of less than 1 tended to underperform the wider market by more than 4%.

The Z-Score is a formula consisting of four to five weighted financial ratios (incorporating information from both the balance sheet and income statement). There are currently several formulas to compute a z-score, each of which is designed for a particular type of company/organization (i.e., Public Companies, Private Companies, and Non-Manufacturer Industrials & Emerging Markets).

The result can be evaluated based on established "Zones", which are broken up into 3 distinct groups:

a) Safe zone : Healthy Company,

b) Grey zone : Warning Signs, and

c) Distress zone : Potential Bankruptcy.

Composition of z- score model

Z- SCORE BANKRUPTCY model:Z = 1.2T1 + 1.4T2 + 3.3T3 + 0.6T4 + .999T5T1 = Working Capital / Total AssetsT2 = Retained Earnings / Total AssetsT3 = Earnings Before Interest and Taxes / Total AssetsT4 = Market Value of Equity / Total LiabilitiesT5 = Sales/ Total Assets

Zone of discrimination:Z ≥ 2.99 -“Safe” Zones1.81 < Z < 2.99 -“Grey” ZonesZ ≤ 1.81 -“Distress” Zones

Z-score estimated for private firms :

Z’ = 0.717T1 + 0.847T2 + 3.107T3 + 0.420T4 + 0.998T5T1 = (Current Assets − Current Liabilities) / Total AssetsT2 = Retained Earnings / Total AssetsT3 = Earnings Before Interest and Taxes / Total AssetsT4 = Book Value of Equity / Total LiabilitiesT5 = Sales/ Total Assets

Zones of Discrimination:Z' ≥ 2.9 -“Safe” Zone1.23 < Z' < 2. 9 -“Grey” ZoneZ' ≤ 1.23 -“Distress” Zone

Z-score estimated for non-manufacturer industrials & emerging market credits

Z'' = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4

T1 = (Current Assets − Current Liabilities) / Total AssetsT2 = Retained Earnings / Total AssetsT3 = Earnings Before Interest and Taxes / Total AssetsT4 = Book Value of Equity / Total Liabilities

Zones of discriminations:Z’’ ≥ 2.6 -“Safe” Zone1.1 < Z’’ < 2. 6 -“Grey” ZoneZ’’ ≤ 1.1 -“Distress” Zone

3 Easy Steps to Calculate the

Z-score:

1To calculate Z-score , the first step is to identify the seven items listed on the balance sheet and income statement used in the calculation:

• Working capital• Total assets• Total liabilities• Market capitalization• Sales• Earning before interest and taxes (EBIT)• Retained earning

2Together, these seven figures are used to create five financial ratios, each identified by Altman as having the greatest forecasting power as to a company's financial strength:

RATIOS :A.Working capital / Total assets B.Retained earnings /total assetsC.EBIT / total assetsD.Market capitalization /total liabilitiesE. Sales / total sales

3The third and final step is to use these ratios in the Z-score formula to create the final value: 

Z-score = 1.2*(A) + 1.4*(B) + 3.3*(C) + 0.6*(D) + 1.0*(E)

The Z Score IngredientsThe Z Score is calculated by multiplying each of several financial ratios by an appropriate coefficient and then summing the results. The ratios rely on these financial measures:

•Working Capital is equal to Current Assets minus Current Liabilities. •Total Assets is the total of the Assets section of the Balance Sheet. •Retained Earnings is found in the Equity section of the Balance Sheet. •EBIT (Earnings Before Interest and Taxes) includes the income or loss from operations and from any unusual or extraordinary items but not the tax effects of these items. It can be calculated as follows: Find Net Income; add back any income tax expenses and subtract any income tax benefits; then add back any interest expenses.

•Net Worth is also known as Shareholders' Equity or, simply, Equity. It is equal to Total Assets minus Total Liabilities. •Book Value of Total Liabilities is the sum of all current and long-term liabilities from the Balance Sheet. •Sales includes other income normally categorized as revenues in the firm's Income Statement.

•Market Value of Equity is the total value of all shares of common and preferred stock. The dates these values are chosen need not correspond exactly with the dates of the financial statements to which the market value is compared.

CALCULATION OF Z-SCORE MODEL :

Z-Score use The Z-Score applies statistical techniques 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.

Z-Score users•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.

•Insurance Underwriting: To evaluate the potential credit risk of the proposed insured including risk sharing and self-insured retentions.

Reasons for Multiple Versions :

Two of the ratios have tended to limit the usefulness of the original Z Score measure.

One of these ratios is, the Market Value of Equity divided by Total Liabilities. Obviously, if a firm is not publicly traded, its equity has no market value. So private firms can't use the Z Score.

The other ratio is, Assets Turnover. This ratio varies significantly by industry. Jewelry stores, for example, have a low asset turnover while grocery stores have a high turnover. But since the Z Score expects a value that is common to manufacturing, it could be biased in such a way that a healthy jewelry store looks sick and a sickly grocery store looks healthy.

How to Interpret the Z- Score :

The Z Score is not intended to predict when a firm will file a formal declaration of bankruptcy in a federal district court. It is instead a measure of how closely a firm resembles other firms that have filed for bankruptcy. It is a measure of corporate financial distress, a measure of economic bankruptcy.

Advantages of z-score model:

• This model is considered to be highly accurate. In more then 72% of the cases, it has been found to successfully predict corporate bankruptcy.

• It is easy to calculate.

• This model can be used to complement other analytical tools.

• This model enables the analysts to incorporate many financialcharacteristics within a single score.

The Disadvantages of Z -score model:

• It focuses only on financial data.

• Z score does not help the management to understand the dynamics of the problems existing in the company.

• The results may turnout out to be inaccurate in case of a corruption ofthe financial data.

• It is not useful for predicting company failure in the current scenario asit is based on out of date assumptions and data.

• Its results do not stand to be that accurate in case of non-manufacturingfirms.

• The values of some quantitative ratios used in this model are prone to change from time to time.

•It is highly generalized in its approach.

APPLICATION OF Z-SCORE MODEL TO KINGFISHER AIRLINES (KFA) :

PARTICULARS FY 11-12

Net sales 6360

EBIT (101)

Market value of equity 1117

Total assets 4106

Total liabilities 9454

Current assets 2974

Current liabilities 4167

Retained earnings (5348)

KFA Financials ( Rs. Cr )

FACTORS RATIOS WEIGHTS Z-SCORET1 -0.29 1.2 -0.35T2 -1.30 1.4 -1.82T3 -0.02 3.3 -0.08T4 0.12 0.6 0.07T5 1.55 0.999 1.55

TOTAL -0.64

ALTMAN Z-SCORE (KFA) :FORMULA (Z)= 1.2T1 +1.4T2+3.3T3+0.6T4+0.999T5

T1 = Working Capital / Total AssetsT2 = Retained Earnings / Total AssetsT3 = Earnings Before Interest and Taxes / Total AssetsT4 = Market Value of Equity / Total LiabilitiesT5 = Sales/ Total Assets

OPEN FOR QUERIES !!!

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