Zeta Model
Candlefocus EditorThe Z-score is calculated using five main financial ratios; working capital to total assets, retained earnings to total assets, EBIT to total assets, sales to total assets and book value of equity to total liabilities. Each ratio is assigned a weighting to form the score and, depending on the specific industry sector, the values may provide the user with crucial information regarding the firm's solvency. Companies with a Z-score above 2.6 are generally seen as financially sound, however a score below 1.8 could be considered a potential cause for concern.
In order to remain relevant, the Zeta Model has undergone a series of studies and changes over the 50-plus years since its conception. The model has various "flavours" in terms of how it is calculated and what is included, such as Altman’s original research which was focused on manufacturing firms and then later expanded to cover sectors such as energy and technology. The most recent model, called ‘Z-Score Plus’, considers criteria such as performance and product metrics and book-to-market ratios.
The Zeta Model provides a useful snapshot of a company's current financial performance and the likelihood that they may become insolvent in the near future. Although the Model was initially developed to enable lenders and creditors to understand a company's level of creditworthiness, other stakeholders such as auditors, Boards of Directors, regulators, shareholders and rating agencies, typically use the Z-score to evaluate and compare a company's financial health.
Despite its long history, the Zeta Model remains an invaluable resource as a tool for the analysis of company operations, financial stability and potential bankruptcy. The ability to quickly assess a company’s financial health provides crucial oversight and the predictive abilities of the Zeta Model can give companies and their stakeholders the information needed for well informed decision-making.