Zeta Model

Posted in Statistics, Total Reads: 456
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Definition: Zeta Model

Zeta model is a mathematical formula which was developed in the late 1960s by named Professor Edward Altman from the NYU, it attempts to express the probability of a public company going bankrupt within a 2-year time frame. The number given by the model is known as as the company's Z-score, which is a reasonably fair predictor of bankruptcy in future.


Explanation:

The zeta model returns a 1 no., known as the z-score that represents the chance of a company going bankrupt in the coming 2 years. The lesser the z-score, more likely is a company going bankrupt. At z-score lower than 1.8. it indicates that bankruptcy is certain, while scores more than 3.0 indicates bankruptcy is uncertain to happen in the upcoming two years. The model is given by:


Z = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

 

Where:

Z = Score

E = Total Assets/Sales

D = Total Liabilities / Market Value of Equity

C = Total Assets/ Earnings before Interest & Tax

B = Total Assets/Retained Earnings

A = Total Assets/ Working Capital


Precaution:

Companies that have a z-score between 1.8 and 3.0 are in the gray area, bankruptcy may not easily be predicted this way or that way.

 

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