algo-risk-altman-z

# Altman Z-Score ## Overview Altman Z-Score is a linear discriminant model predicting bankruptcy probability from five financial ratios. Z = 1.2X₁ + 1.4X₂ + 3.3X₃ + 0.6X₄ + 1.0X₅. Zones: Z > 2.99 (safe), 1.81-2.99 (grey), Z < 1.81 (distress). Originally for public manufacturing firms; variants exist for private and non-manufacturing. ## When to Use **Trigger conditions:** - Screening companies for bankruptcy risk - Quick credit assessment using publicly available financials - Monitoring portfolio companies for financial distress signals **When NOT to use:** - For financial institutions (banks, insurers) — different capital structures - When detailed credit scoring is needed (use logistic regression credit models) ## Algorithm ``` IRON LAW: Z-Score Was Calibrated for PUBLIC MANUFACTURING Firms Applying the original formula to private firms, service companies, or emerging markets WITHOUT using the appropriate variant produces misleading results. Use Z'-Score for private firms, Z''-Score for non-manufacturing and emerging markets. ``` ### Phase 1: Input Validation Extract from financial statements: working capital, retained earnings, EBIT, market cap (or book equity for private), total assets, total liabilities, sales. **Gate:** All five inputs available, from same reporting period. ### Phase 1.5: Variant Selection (MANDATORY) Before touching any formula, pick the right variant — this is the single most common mistake when applying Altman Z. | Firm description | Varia...