One of the tools used by financial analysts to assess the viability of a business is Altman’s Z-score. Corporate failure is linked to a series of actions which are related to a company’s fundamentals which long-term reflect the likelihood of a business going bankrupt. According to this statement, Prof.E.I.Altman developed in 1968 a multivariate statistical model considering a linear combination of several financial ratios that allow to differentiate between failing companies a non-failing ones.
Altman, Edward I., 1968. ‘Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy’, Journal of Finance, 23, pp.589-609.
The result obtained from the model gives what is known as the Z-score. Low values indicate the company has a high probability of failing while high values predict the company is less likely to fail. In fact, Altman’s seminal work predicted correctly 72% of the bankrupted companies two years prior to the event. However, the Z-score is an explanatory tool rather than an instrument to forecast business viability, and this tool should only be used as a baseline or a first approach to viability assessment. For instance, Altman himself suggests to analyse thoroughly those companies with lower Z-index values while resources and time can be saved with those obtaining higher values.
Based on Altman’s work, Prof.R.Taffler estimated a similar model for the UK economy in the eighties. This Taffler Z-score raises the same concerns as the original one, but it is as useful as Altman’s to explain/stablish a first approach to business viability; in this case, based on UK data.
Taffler, R.J., 1982.’Forecasting company failure in the UK using discriminant analysis and financial ratio data’. Journal of the Royal Statistical Society, Series A, 145, pp.342-358.
Taffler, R.J., 1983. ‘The assessment of company solvency and performance using a statistical model’. Accounting and Business Research, 15, pp.295-308.
We are working in a new addition to our free Android app that will allow you to calculate this latter score for a UK company.
Update: you can find the UK version in here.