Original Research Article DOI: 10.18231/2394-2770.2017.

0027

PREDICTING BANKRUPTCY OF SELECTED FIRMS BY APPLYING ALTMAN’S Z-SCORE

MODEL

Dr. Nilam Panchal1

1
B.K.School of Business Management, Gujarat University, Ahmedabad

Abstract: Financial health is of great concern for a business firm. For measuring the financial health of a
business firm, there are lots of techniques available. However, Altman’s “Z-score” has been proven to be a
reliable tool. This model envisages predicting the possibilities of bankruptcy of manufacturing organization. The
“Z score” analysis has been adopted to monitor the financial health of the company. The current study has been
conducted to assess the financial health of firms namely Hindustan Uniliver Ltd, Colgate Palmolive, Nestle, ITC
and P&G. All the above companies are manufacturing firms. The research used secondary data from the
financial reports of five manufacturing companies for a period of the five years from 2013 to 2017. The study
reveals that none of the companies completely belongs to Safe Zone except for few years. Most of the firms are
in Distress Zone which clearly indicates that these firms may go Bankrupt in near future.
Keywords: Bankruptcy; Altman’s Z-Score Model.

1) Introduction
The objective of all organizations is to create and increase shareholder value. All stake holders, including banks,
financial institutions, regulatory bodies, the government, suppliers, customers, etc. want them to do well and be
effectively and efficiently managed to prevent driving them to the brink of business failure/bankruptcy and then
pushing them to failure, if mismanagement continues. To achieve profit maximization objective, firm needs
strong internal & external support. Bankruptcy is a situation where the firm’s total liabilities exceed total assets.
The real net worth of the firm is, therefore negative. This leads to reduced sales, increased cost & losses,
ineffective competition etc. Ultimately firm is under distress stage. Under such situations it becomes difficult for
investors & lenders to analyze the financial performance of the organization. Several bankruptcy models for
example, logit analysis, recursive portioning algorithm and neural networks are available but still Altman’s
model is considered to be superior and pervasively applied by researchers all over the world in the present days.
Altman’s Z-Score Model is the output of a credit-strength test that predicts company's likelihood of bankruptcy.
2) Literature Review
Sanesh (2016) tried to assess the Altman Z-score of NIFTY 50 companies excluding banks and financial
companies. The score tries to predict probability of default by the companies due to the financial distress based
on the current financial statistics of the company. Kumari’s (2013) paper tried to predict bankruptcy for MMTC
based on Altman’s model of the Z score. She concluded that the overall financial health of MMTC is good, and
it can be quoted as an investor friendly company. Ramana Reddy and Hari Prasad Reddy (2013) is also relevant.
In this article, the Z score analysis shows the poor financial performance leading to bankruptcy of Chittoor co-
operative sugars Ltd. Comparatively the financial performance of Sri Venkateswara Sugars Factory Ltd. was
good.
Vikas Tyagi (2014) in his paper investigated the financial health of logistic industry in India based on Z score
analysis. It reveals that Indian logistic industry was healthy industry .It is good that average Z score value
increases from 2006 to 2010 (2.54 to 3.01) when Indian economy was hit by global recession. This indicates the
overall performance of Indian logistic industry was good. Al-Rawi, Kiani and Vedd (2008) used the Altman z-
score analysis to predict a firm’s insolvency. They have remarked that the firm has increased its debt and face
bankruptcy in the near future.
Mizan and Hossain’s (2014) study has been conducted to assess the financial health of cement industry of
Bangladesh. The study revealed that among the five firms, two firms are financially sound as they have higher
Z score than the benchmark (2.99). Another firm is in the grey area that is the firm is financially sound, but the
management requires special attention to improve the financial health of the organization. The other two firms
are at serious risk of financial crisis.
Gerantonis Vergos and Christopoulos (2009) investigated whether Z-score models can predict bankruptcies for a
period up to three years earlier. Results showed that Altman model performed well in predicting failures. They
concluded that the results can be used by company management for financing decisions, by regulatory
authorities and by portfolio managers in stock selection.
Alkhatib and Al Bzour (2011) conducted a study to report the effect of financial ratios in bankruptcy prediction
in Jordanian listed companies through the use of Altman and Kida models. They suggested that the Jordanian
listed companies should at least apply one of these models with high credibility for predicting corporate
bankruptcy. Among others, corporate bankruptcy prediction model developed by Altman in 1968 is the most
accepted and widely used tool (Mizan, Amin and Rahman 2011).The Altman Z score model is used in different
countries for predicting bankruptcy.

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Dr. Nilam Panchal PREDICTING BANKRUPTCY OF SELECTED ………..

Mizan, Amin, and Rahman (2011) conducted a study for the prediction of bankruptcy of the pharmaceutical
industry in Bangladesh. They used the Altman Z-score Model for this purpose where sample size was six
leading companies of this industry. Their study reveals some valuable findings like, two firms are found
financially sound having no bankruptcy possibility in the near future and other companies are found to be
unsatisfactory and they have a significant likelihood of facing financial crisis in the near future. They also stated
that market value of equity of most of the firms is not reflecting the fundamentals of the respective companies.
Altman and Beaver showed that a financial statement as sufficient information for a highly discriminate function
of large businesses (Kim-Soon et al., 2013)
Chowdhury and Barua (2009) applied Z score model to the Z category shares traded in DSE to judge financial
distress risk of each share. They used 53 companies’ data of the years 2000-2005 to calculate Z-score. They
argued that the Altman’s Z score model, though may not be fully applicable for companies in Bangladesh, yet
proves its strong validity and correctness in predicting distressful status of the Z category companies.
Ramaratnam and Jayaraman (2010) measured financial soundness of Indian steel industry by using Z score
model. The study was based on five years’ data (2006-2010) of five firms of the steel industry. Their study
revealed that all the selected companies are financially sound during the study period.
The importance of the Z score has been highlighted by a number of studies. A study conducted by Price water
Coopers (2002) on 1,200 publicly owned manufacturing companies (data from 1998 to 2001) concluded that the
Z-score remains a viable measure of financial distress. It has been used to predict viability in a number of
sectors like telecommunications (Permatasari, 2006), wood industry (Muhammad, 2008), pharmaceuticals
(Ambarsari, (2009), etc. In all these situations, it was found that the respective industries were in distress
financial situation, which was later proved correct. The studies thus proved that Altman model of Z-score would
provide accurate prediction of financial distress.
3) Objectives Of The Study
This study intends to estimate likelihood of Bankruptcy of selected firms by applying Altman’s Z-Score Model.
4) ALTMAN’S Z-SCORE MODEL
Edward Altman Finance Professor of the Leonard N. Stern School of Business of New York University has
developed the Financial Model in 1967 to predict the likelihood of bankruptcy of the company which is named
as Altman’s Z-Score Model. Later, in 2012 he released an updated version called the Altman’s Z-Score plus
Model that can be used to evaluate both manufacturing & non-manufacturing firms & public & privative
companies in both U.S & non-U.S companies. Altman added a statistical technique called multivariate analysis
to the mix of traditional ratio-analysis techniques, and this allowed him to consider not only the effects of
several ratios on the "productiveness" of his bankruptcy model, but to consider how those ratios affected each
other's usefulness in the model. The model formed by Altman for predicting a company’s financial health is as
follows;
4.1. The original z-score formula or for manufacturing firms
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
[X1-Working Capital/Total Assets]
The Working capital/Total assets ratio, frequently found in studies of corporate problems, is a measure of the net
liquid assets of the firm relative to the total capitalization Working capital is defined as the difference between
current assets and current liabilities. Liquidity and size characteristics are explicitly considered. Ordinarily, a
firm experiencing consistent operating losses have shrinking current assets in relation to total assets. Of the three
liquidity ratios evaluated, this one proved to be the most valuable. 22 Inclusion of this variable is consistent with
the Merwin study which rated the net working capital to total asset ratio as the best indicator of ultimate
discontinuance.
[X2-Retained Earnings/Total Assets]
This measure of cumulative profitability over time was cited earlier as one of the "new" ratios. The age of a firm
is implicitly considered in this ratio. For example, relatively young firms are probably showing a low RE/TA
ratio because it has not had time to build up its cumulative profits. Therefore, it may be argued that the young
firm is somewhat discriminated against in this analysis, and its chance of being classified as bankrupt is
relatively higher than another, older firm. But, this is precisely the situation in the real world. The incidence of
failure is much higher in a firm's earlier.
[X3-Earnings before Interest and Taxes/Total Assets]
This ratio is calculated by dividing the total assets of a firm into its earnings before interest and tax reductions.
In essence, it is a measure of the true productivity of the firm's assets, abstracting from any tax or leverage
factors. Since a firm's ultimate existence is based on the earning power of its assets, this ratio appears to be
particularly appropriate for studies dealing with corporate failure. Furthermore, insolvency in a bankruptcy

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Dr. Nilam Panchal PREDICTING BANKRUPTCY OF SELECTED ………..

sense occurs when the total liabilities exceed a fair valuation of the firm's assets with value determined by the
earning power of the assets.
[X4-Market Value of Equity/Book Value of Total Debt]
Equity is measured by the combined market value of all shares of stock, preferred and common, while debt
includes both current and long-term. The measure shows how much the firm's assets can decline in value
(measured by market value of equity plus debt) before the International Letters of Social and Humanistic
Sciences Vol. 26 95 liabilities exceed the assets and the firm becomes insolvent. This ratio adds a market value
dimension which other failure studies did not consider. It also appears to be a more effective predictor of
bankruptcy than a similar, more commonly used ratio: Net worth/Total debt (book values).
[X5-Sales/Total Assets]
The capital-turnover ratio is a standard financial ratio illustrating the sales generating ability of the firm's assets.
It is one measure of management's capability in dealing with competitive conditions. This final ratio is quite
important because, as indicated below, it is the least significant ratio on an individual basis. In fact, based on the
statistical significance measure, it would not have appeared at all. However, because of its unique relationship to
other variables in the model, the Sales/Total assets ratio ranks second in its contribution to the overall
discriminating ability of the model. The Z-Score, which as aforementioned is a survival indicator, classifies
companies based on their solvency. The higher the value is, the lower the risk of bankruptcy. A low or negative
Z-Score indicates high likelihood of bankruptcy. Altman set critical values between companies based on the
survivability indicator which is given in table-1 as under:

Z- Score Zone Result

Z > 2.99 Safe Zone Safe
1.81< Z < 2.99 Gray Zone Stable
Z < 1.81 Distress Zone likely to be bankrupt

Z score bankruptcy model

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + .999X5

5. Research Methodology
5.1. Data Collection & Research Sample
The study depends on the secondary source & annual reports (financial statements) are collected from the
websites of respective organizations. The time frame of data being collected is set for 5 years i.e. from 2013 to
2017. Study covers the sample size of 5 companies which listed in Indian stock exchanges off which all firms
are from manufacturing sector. In each sector, the companies are selected based on the high profits, high loss &
average profit/loss earned by them in each year. And it also considers the assets & liabilities of companies while
selecting the sample.
The collected data is analyzed by using MS Excel.
5.2. List of selected manufacturing firms for this study:
 HUL (Hindustan Unilever Limited)
 Colgate-Palmolive
 ITC Limited
 Nestle
 P&G (Procter and Gamble)
6. Data Analysis & Findings
Hindustan Unilever Limited
Particulars Mar-17 Mar-16 Mar-15 Mar-14 Mar-13
X1 -0.386193733 -0.066102131 -0.119190894 -0.348164743 -0.44578151
X2 0.738985208 0.544501841 0.48682504 0.485700682 0.587517534
X3 0.982503579 1.790495811 1.487587638 1.475939909 1.63638506
X4 0.752145054 0.304106738 0.327258057 0.3290789 0.359033793
X5 1.03228885 1.116937573 1 1 1
Zscore 4.278801334 6.795213341 5.643723669 5.330034857 5.902862289
(The Z-score value for HUL ltd results based Altman’s Z score bankruptcy model its more than >2.99 , So it
means that the HUL ltd is in the safe and healty financial zone)

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Dr. Nilam Panchal PREDICTING BANKRUPTCY OF SELECTED ………..

Colgate Palmolive
Particulars Mar-17 Mar-16 Mar-15 Mar-14 Mar-13
X1 -0.160466398 -0.139274671 -0.296088588 -0.377154669 -0.045607729
X2 0.812122362 0.691187878 0.529799691 0.486613543 0.471109659
X3 0.768986913 0.913292034 1.013085641 1.106224786 1.354200282
X4 0.000234694 0.000293244 0.000194045 0.000249178 0.00030531
X5 3.596264485 4.422839473 5.169269515 5.966075418 6.461898246
Zscore 7.074877479 8.232989716 8.893812549 9.839473999 11.52930471
(The Z-score value for Colgate Palmolive results based Altman’s Z score bankruptcy model its more than >2.99
, So it means that the Colgate Palmolive is in the safe and healty financial zone)
ITC Ltd
Particulars Mar-17 Mar-16 Mar-15 Mar-14 Mar-13
X1 0.199809239 0.111592181 0.197446904 0.12089996 0.116167172
X2 0.476442508 0.386502548 0.348556917 0.296482825 0.234520058
X3 0.371238398 0.492734818 0.456708823 0.481206362 0.481816657
X4 7.3901E-05 6.74839E-05 7.19967E-05 8.35727E-05 9.77742E-05
X5 0.958556203 1.209464633 1.186291203 1.263193018 1.337610074
Zscore 3.089519298 3.509334742 3.417203195 3.410116871 3.394054783
(The Z-score value for ITC ltd results based Altman’s Z score bankruptcy model its more than >2.99 , So it
means that the ITC ltd is in the safe and healty financial zone they have to improve in financial postion)
Nestle
Particulars Mar-17 Mar-16 Mar-15 Mar-14 Mar-13
X1 0.199809239 0.111592181 0.197446904 0.12089996 0.116167172
X2 0.476442508 0.386502548 0.348556917 0.296482825 0.234520058
X3 0.371238398 0.492734818 0.456708823 0.481206362 0.481816657
X4 7.3901E-05 6.74839E-05 7.19967E-05 8.35727E-05 9.77742E-05
X5 0.958556203 1.209464633 1.186291203 1.263193018 1.337610074
Zscore 3.089519298 3.509334742 3.417203195 3.410116871 3.394054783
(The Z-score value for Nestle results based Altman’s Z score bankruptcy model its more than >2.99 , So it
means that the Nestle is in the safe and healty financial zone)
P&G
Particulars Mar-17 Mar-16 Mar-15 Mar-14 Mar-13
X1 -0.377670493 0.628585361 0.32119022 0.179738758 0.093478369
X2 0.691876378 0.785701224 0.741071719 0.705922824 0.640180301
X3 1.296643351 0.433839714 0.412255429 0.464363346 0.355399096
X4 0.000601138 0.000209283 0.000257407 0.000315356 0.000392727
X5 4.410400669 1.682591822 1.899428655 2.045009473 2.094546267
Zscore 9.200696348 4.966990005 4.681055256 4.779531182 4.273930838
(The Z-score value for P&G results based Altman’s Z score bankruptcy model its more than >2.99 , So it means
that the P&G is in the safe and healty financial zone)
6.1. Z Value & Firm’s Classification:
This table indicate & interoperates the Z-score results during 2013-17 with Zones status of five selected
manufacturing companies
Company Year Z-value Zone
HUL 2017 4.278801334 safe
2016 6.795213341 safe
2015 5.643723669 safe
2014 5.330034857 safe
2013 5.902862289 safe
Colgate Palmolive 2017 7.074877479 safe
2016 8.232989716 safe

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Dr. Nilam Panchal PREDICTING BANKRUPTCY OF SELECTED ………..

2015 8.893812549 safe

2014 9.839473999 safe
2013 11.52930471 safe
ITC Ltd 2017 3.089519298 safe
2016 3.509334742 safe
2015 3.417203195 safe
2014 3.410116871 safe
2013 3.394054783 safe
Nestle 2017 3.089519298 safe
2016 3.509334742 safe
2015 3.417203195 safe
2014 3.410116871 safe
2013 3.394054783 safe
P&G 2017 9.200696348 safe
2016 4.966990005 safe
2015 4.681055256 safe
2014 4.779531182 safe
2013 4.273930838 safe
7. Interpretation
The above table shows that from the selected sample of 5 manufacturing companies that are all the financial
position of companies are good and It never fell to less than 1.8 according to the Z score analysis it has a small
probability of the firm facing financial distress in the near future.
The fundamental financial health of a business firm is the main concern for the stakeholders. On the basis of the
financial soundness, they take a decision regarding their possible involvement with a particular firm. The
Altman Z score is the best measurement that can shape the decision of the stakeholders.
8. Conclusion
This study examined the applicability of the Altman’s bankruptcy model to examine the financial reliability of
the firms belonging to the manufacturing firms. The study covers the 5 companies & 5 years of time frame from
2013-2017. According to findings fortunately, all of the companies completely belongs to Safe Zone for selected
years. All of the firms are in Safe Zone which clearly indicates that these firms may not go Bankrupt in near
future. It’s up to top level management to design effective strategies for better control & management of
resources that help these firms to keep constant and improve financial position that is very important for
financial reputation.
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Journal of Management Research and Analysis, October-December, 2017; 4(4):186-191