![]() ![]() This shows the ability of the firm's assets to generate sales - the lifeblood of any company. This measure shows how far a company's assets (measured here by its market capitalisation) can decline in value before they are less than its liabilities - which could mean that it is insolvent. Altman found that this was a particularly good predictor of bankruptcy and was even better than looking at a company's cash flow.ĭ: Market capitalisation/Total Liabilities Good, strong companies have big profits in relation to their assets. ![]() Companies with a high retained profits to total assets ratio tend to have financed their business with profits rather than relying on lots of debt - a good sign according to Altman. Small retained profits are found in weak or young companies which are more likely to fail. Retained profits are a company's cumulative total profits which have not been paid out to shareholders since it was created. Altman saw that a low or negative level of working capital relative to the size of the firm (its total assets) was a sign of weak finances. It is a measure of a company's liquidity. Working capital is the difference between a company's current assets (things that can be turned into cash within one year) and current liabilities (bills or debts that have to be paid within a year). Let's have a look at them in turn and see why they are useful. However, as with all financial ratios and calculations, understanding how they are worked out and what they mean is a very useful process for investors.Īltman found the five financial ratios (labelled A to E) held the key to predicting trouble ahead. If you have a copy of SharePad or ShareScope then there's no need to bother with this as the calculation is done for you. ![]() It looks a little complicated at first glance, but a Z-Score can be easily calculated in a spreadsheet or with a calculator and a bit of paper. What he came up with was a formula that has proven to be a reasonably good predictor of future financial distress. Altman studied lots of non-financial companies and crunched 22 different financial ratios with numbers taken from their accounts. Back in the late 1960's, Edward Altman, a professor of finance at New York University set about finding a way to predict which companies were heading for bankruptcy. ![]()
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