What Is the Zeta Model?
The Zeta Model is a mathematical model that estimates the chances of a public company going bankrupt within a two-year time period. The number produced by the model is referred to as the company's Z-score (or zeta score) and is considered to be a reasonably accurate predictor of future bankruptcy.
The model was published in 1968 by New York University professor of finance Edward I. Altman. The resulting Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.
Key Takeaways
- The Zeta Model is a mathematical model that estimates the chances of a public company going bankrupt within a certain time period.
- The Zeta Model was developed by New York University professor Edward Altman in 1968.
- The resulting Z-score uses multiple corporate income and balance sheet values to measure the financial health of a company.
The Formula for the Zeta Model Is
ζ=1.2A+1.4B+3.3C+0.6D+Ewhere:ζ=scoreA=working capital divided by total assetsB=retained earnings divided by total assetsC=earnings before interest and tax divided by total assetsD=market value of equity divided by total liabilitiesE=sales divided by total assets
What Does the Zeta Model Tell You?
The Zeta Model returns a single number, the z-score (or zeta score), to represent the likelihood of a company going bankrupt in the next two years. The lower the z-score, the more likely a company is to go bankrupt. The Zeta model’s bankruptcy prediction accuracy has been found to range from more than 95% percent one period prior to a bankruptcy to 70% for a series of five prior annual reporting periods.
Z-scores exist in so-called zones of discrimination, which indicates the likelihood of a firm going bankrupt. A z-score lower than 1.8 indicates that bankruptcy is likely, while scores greater than 3.0 indicate bankruptcy is unlikely to occur in the next two years. Companies that have a z-score between 1.8 and 3.0 are in the gray area, and bankruptcy is as likely as not.- Z > 2.99 -“Safe” Zones
- 1.81 < Z < 2.99 -“Grey” Zones
- Z < 1.81 -“Distress” Zones