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Trading and Investment Terms

Zeta Model

The Zeta Model is a mathematical model that evaluates the odds of a public company failing and facing bankruptcy within a two-year timeframe.

The number delivered by the model is referred to as the Z-score of the company. The number is viewed to be a reasonably precise indicator of future bankruptcy.

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

where:
A=working capital divided by total assets
B=retained earnings divided by total assets
C=earnings before interest and tax divided by total assets
D=market value of equity divided by total liabilities
E=sales divided by total assets

The model was published in 1968 by Edward I. Altman. He was a professor of finance in the New York University.

The subsequent Z-score uses numerous corporate income and balance sheet records to quantify the financial strength of a company.

The Zeta model formula returns a single number, the z-score, to represent the probability of a company going for bankruptcy in the following two years.

The lower the z-score, the more probable a company will go bankrupt.

The Zeta model’s bankruptcy forecast prciseness has been found to go from over 95% percent one period before a bankruptcy to 70% for a progression of five prior annual reportings.

Z-scores have so-called zones of separation, which demonstrates the probability of a company going bankrupt.

Z > 2.99 - Safe Zone
1.81 < Z < 2.99 – Grey Zone
Z < 1.81 - Distress Zone

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