Financial analysts first assess the viability of a business using Altman’s Z-score. Corporate failure is linked to a series of actions which relate to the company’s fundamentals, and in the long-term reflect the likelihood of a business going bankrupt. According to this statement, Prof. E. I. Altman developed in 1968 a multivariate statistical model considering a linear combination of several financial ratios that allow to differentiate between failing companies and non-failing ones.
The result obtained from the model gives what is known as the Z-score. Low values indicate the company has a high probability of failing while high values predict the company is less likely to fail. In fact, Altman’s seminal work predicted correctly 72% of the bankrupted companies two years prior to the event.
However, the Z-score is an explanatory tool rather than an instrument to forecast business viability, and this tool should only be used as a baseline or a first approach to viability assessment. For instance, Altman himself suggests to analyse thoroughly those companies with lower Z-index values while resources and time can be saved with those obtaining higher values.