Altman Z score formula for financial statement analysis

The Z score formula for financial statement analysis usually means Altman's weighted financial-distress indicator, built from five ratios. Use the version appropriate to the company, calculate each contribution separately, and investigate the inputs behind any change. The original version is a historical screening framework, not a current bankruptcy probability or a substitute for reviewing cash obligations.

Choose the applicable version first

The original formula covered US manufacturers with publicly traded equity, as NYU Stern explains when distinguishing the original score from later variants. This matters because market equity is an input and sales relative to assets varies with the business's operating structure.

Do not apply this equation automatically to a bank, a service company or a privately held distributor. Later private-company and nonmanufacturing variants have different specifications. Selecting a variant requires an explicit reason; switching equations between periods destroys comparability.

This article works the original public-manufacturer formula. The ordinary statistical z-score, used to describe distance from a mean, answers a different question.

The original formula and its inputs

Z = 1.2 × X1 + 1.4 × X2 + 3.3 × X3 + 0.6 × X4 + 1.0 × X5

X1 = (Current assets − Current liabilities) / Total assets

X2 = Retained earnings / Total assets

X3 = Earnings before interest and taxes / Total assets

X4 = Market value of equity / Book value of total liabilities

X5 = Sales / Total assets

These are the coefficients and definitions in Edward Altman's paper on credit-scoring approaches, page 14. Enter ratios as decimals, not whole-number percentages. The formula has no added constant.

Build an input sheet with one column per reporting year. Take current assets, current liabilities, total assets, retained earnings and total liabilities from the same consolidated balance sheet. Take annual EBIT and sales from the matching income statement and its supporting schedules. Add a documented share count and closing share price for the balance-sheet date to calculate market equity.

Balance-sheet amounts are measured at a date; income-statement amounts cover a period, a distinction explained in the SEC's guide to financial statements. Here, annual flows are divided by closing assets according to the stated formula. Do not quietly replace closing assets with average assets.

A worked example from a manufacturer's workbook

Cedar Forge Manufacturing is a fictional US public manufacturer. Its workbook supplies the following annual figures, with no intangible assets. Both periods end on December 31, and all monetary inputs use USD throughout.

Calculate the ratios before applying the weights. Displayed ratios below are rounded to four decimals; contributions and final scores are rounded to three. All totals use unrounded calculations.

For 2025, the unrounded calculation is:

=1.2*(4200000-3800000)/12000000
 +1.4*2200000/12000000
 +3.3*600000/12000000
 +0.6*8000000/8000000
 +15600000/12000000

Keep separate cells for the inputs and contributions in a working spreadsheet. The expanded expression above makes the arithmetic visible; hard-coded figures are unsuitable for a recurring review.

Prove the score and explain its movement

First, reconcile the source inputs. In 2024, assets of $10,000,000 equal liabilities of $6,000,000 plus book equity of $4,000,000. In 2025, $12,000,000 equals $8,000,000 plus $4,000,000. Market equity belongs in X4; it does not replace book equity in this balance-sheet identity.

Next, check that the change in contributions equals the change in the total score.

The score falls by 2.362 − 3.490 = −1.128 at the displayed precision. The largest contribution is the market-equity term. Retained earnings rose in dollars, yet its contribution fell because assets grew faster. Sales also rose in dollars while sales relative to assets weakened.

As a sensitivity check, hold every 2025 input constant except market equity, replacing it with the earlier $12,000,000. The equity contribution increases by 0.6 × (12,000,000 − 8,000,000) / 8,000,000 = 0.300, making the score 2.662. This isolates an input effect; it does not estimate what the share price should be.

Turn the result into investigation questions

Finance should ask why current liabilities grew, whether the new assets are generating their expected sales, and what reduced EBIT. Treasury should separately inspect available cash and upcoming payments. A score does not show whether an obligation falls due before customer receipts arrive.

Use financial distress analysis for the wider review of liquidity, cash generation and coverage. For transaction-specific historical comparisons, financial statement analysis in mergers and acquisitions covers the questions raised by target-company accounts. Keep the original statements and the input mapping available for whoever reviews the score.

Where it goes wrong

• Wrong company population. Applying the public-manufacturer equation to a different business does not validate its interpretation. Choose and document an appropriate specification first.
• Changing the equity definition. Substituting book equity for market equity while retaining these coefficients creates a hybrid calculation.
• Mixed dates or units. A current share price combined with an old balance sheet, or thousands mixed with dollars, can move the result without an operating change.
• Replacing accumulated earnings with annual profit. Retained earnings are a balance-sheet stock. Annual earnings are a different input and cannot stand in for them.
• Turning a score into a probability. Historical classification boundaries are not a current probability calibration. A calculated score alone cannot support a lending decision or a securities recommendation.

Check your statement workbook in Covirage

Bring a sample of your own statement workbook with the applicable formula, reporting dates and documented equity inputs; Covirage maps the columns and its tools compute the ratios and check their contributions against the supplied rows. The external AI model explains the result with every figure traced to its rows, so the review can focus on the inputs behind the movement. Create a free Covirage account and bring a sample of your own data.

See Covirage for finance teams for the wider reporting context.