The role of the altman model in the scoring model for assessing the creditworthiness of businesses in free economic zones jasur Umirzokov


Table 1 Modifications to Altman’s Z-score model4



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Table 1

Modifications to Altman’s Z-score model4


1

Original Z-score component definitions

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

X5 = sales / total assets

Z-score bankruptcy model:

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1X5

Zones of discrimination:

Z > 2.99 – "safe" zone

1.81 < Z < 2.99 – "grey" zone



Z < 1.81 – "distress" zone

2

Z-score estimated for non-manufacturers and emerging markets


X1 = (current assets − current liabilities) / total assets

X2 = retained earnings / total assets

X3 = earnings before interest and taxes / total assets

X4 = book value of equity / total liabilities

Z-score bankruptcy model (non-manufacturers):

Z = 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4

Z-score bankruptcy model (emerging markets):

Z = 3.25 + 6.56X1 + 3.26X2 + 6.72X3 + 1.05X4

Zones of discrimination:

Z > 2.6 – "safe" zone

1.1 < Z < 2.6 – "grey" zone



Z < 1.1 – "distress" zone

Usually, the lower the Z-score, the higher the odds that a company is heading for bankruptcy. A Z-score that is lower than 1.8 means that the company is in financial distress and with a high probability of going bankrupt. On the other hand, a score of 3 and above means that the company is in a safe zone and is unlikely to file for bankruptcy. A score of between 1.8 and 3 means that the company is in a grey area and with a moderate chance of filing for bankruptcy.

Investors use the Altman’s Z-score to make a decision on whether to buy or sell a company’s stock, depending on the assessed financial strength. If a company shows a Z-score closer to 3, investors may consider purchasing the company’s stock since there is minimal risk of the business going bankrupt in the next two years.

However, if a company shows a Z-score closer to 1.8, the investors may consider selling the company’s stock to avoid losing their investments since the score implies a high probability of going bankrupt.



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