Money Talk The Z-Score Recently, a lending institution asked a company The fiscal fitness of your company. By Stuart Margolis owner for the company’s “Z-Score.” Perplexed by the request, the owner called us for a calculation. Here is scoop on the Z-Score: The Z-Score was developed in the 1960s by Edward I. Altman, a business professor at New York University. Dr. Altman researched many companies that had gone bankrupt, and others that were thriving. He eventually focused on five key financial ratios as determinants of financial success. He assigned a weight to each of the five, multiplying each ratio by a weighted number to indicate the relative importance he derived through research and practice. The sum of the weighted ratios is the Z-Score. Like many other ratios, the Z-Score is an indicator that can be used to see how your company is doing on its own, and how it compares to others in your industry. It is common for banks and investors to use the Z-Score to determine fiscal fitness. The Z-Score takes into account eight variables from a company’s financial statements: From the Income Statement Example Earnings Before Interest and Taxes (EBIT) .......................................... Loss ($ 250,000) Net Sales ................................................................. $6,700,000 From the Balance Sheet Total Assets ........................................................... $3,000,000 Market Value of Equity ........................................... $ 500,000 Total Liabilities ...................................................... $2,850,000 Current Assets ........................................................ $ 900,000 Current Liabilities ................................................. $1,500,000 Retained Earnings ...................................................$ 150,000 The eight variables are used to comprise the following five ratios. The chart below also shows the weight assigned to each ratio in determination of Z-Score. To derive your Z-Score the calculation is: Z Score =EBIT/Total Assets(3.3) + Net Sales/Total Assets (0.99) + Market Value of Equity/Total Liabilities (0.6) + Working Capital/Total Assets (1.2) + Retained Earnings/Total Assets (1.4) Stuart Margolis Margolis Partners has long been recognized as the financial expert for family-owned businesses with a specialty in the printing, packaging and allied graphic communications industries. The firm is noted for its expertise in enabling companies to optimize profits. Proudly, it is the purveyor of the industry’s Value-Added Principles of Management, and compiles the annual Printing Industries of America Ratios, the printing industry’s premier financial benchmarking. Ratio Weight Range Limit A EBIT/Total Assets -4 x. 3.3 to +8.0 B Net Sales /Total Assets -4 x 0.999 to +8.0 C Market Value of Equity/ Total Liabilities -4 x 0.6 to +8.0 D Working Capital/ Total Assets -4 x 1.2 to +8.0 E Retained Earnings/ Total Assets -4 x1.4 to +8.0 Our Example firm created the follow Z-Score: Ratio Factor Factor Result Weight Result A EBIT/ Total Assets $(250,000)/ $3,000,000= (0.08)x 3.30= (0.28) B Net Sales/ Total Assets $6,700,000/ $3,000,000= 2.23x 0.99= 2.21 C Market Value of Equity/ Total Liabilities $500,000/ $2,850,000= 0.18x 0.60= 0.11 D Working Capital/ Total Assets $(600,000)/ $3,000,000= (0.20)x 1.20= (0.24) E Retained Earnings/ Total Assets $150,000/ $3,000,000= 0.05x 1.40= 0.07 Z-SCORE (Add A+B+C+D+E) 1.87 Interpretation of Z-Score: ABOVE 3.0 The company is considered financially sound based on these financial figures. BETWEEN 2.7 and 2.99 The company is at risk and should exercise caution financially. BETWEEN 1.8 and 2.7 Could be a chance of the company heading towards bankruptcy within 2 years of operations from the date of financial figures given. BELOW 1.80 The company is heading towards bankruptcy. Our example firm resulted in a factor of 1.87 and fell into the “Could be a chance of the company heading towards bankruptcy within two years of operations from the date of financial figures given.” In reality, they fell towards the bottom range of this category. This particular company was sold, instead of moving into bankruptcy, almost two years after these results received! In recent years, we’ve helped companies with less than favorable Z-Scores turn around and thrive. If you are in trouble, call and get help. 26 Quick Printing | April 2015 MyPRINTResource.com
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