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What is the Altman Z-score for solar PV Manufacturers?

What is the Altman Z-score?

The Altman Z-score is a formula to predict bankruptcy. This formula is used to predict corporate defaults and the status of financial distress. The formula uses the factors profitabilityliquidity, leverageactivity and solvency to predict if a firm will go into bankruptcy within two years.

As the Altman Z-score was originally designed to assess public manufacturing companies with assets of more than USD 1 million, this formula is an excellent way to assess which PV module manufacturers may be in trouble within the next 2 years.

The formula is nowadays widely accepted by auditors, accountants, courts and database systems used to evaluate loans.

The formula dates from the 1960’s and was published by Edward L. Altman, who back then was working as an Assistant Professor of Finance at New York University.

How reliable is the Altman Z-score formula?

The Altman Z-Score isn’t perfect, however we’d say it’s reliable enough to make a proper judgment on the financial situation of a PV module manufacturer:

Between 1968 and 1999 the formula has been put to the test multiple times. The model was found to be about 80-90% accurate in predicting bankruptcy one year before the event (with a Type II error, classifying the firm as bankrupt when it does not go bankrupt of approximately 15%–20%*).

(*Source: pages.stern.nyu.edu/~ealtman/Zscores.pdf)

How’s the Altman Z-score calculated?

Altman Z-Score formula = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

The original formula is broken down as following:

A = Working Capital/Total Assets: measures liquid assets in relation to the size of the company

B = Retained Earnings/Total Assets: measures profitability that reflects the company’s age and earning power

C = Earnings Before Interest & Tax/Total Assets: measures operating efficiency apart from tax and leveraging factors. It recognizes operating earnings as being important to long-term viability

D = Market Value of Equity/Total Liabilities: adds market dimension that can show up security price fluctuation as a possible red flag

E = Sales/Total Assets: standard measure for total asset turnover

How are the Altman Z-scores interpreted?

The scores are categorized into 3 zones called the Safe ZoneGrey Zone and Distress Zone:

Safe Zone = Z > 2.6

Grey Zone = 1.1 < Z < 2.6

Distress Zone = Z < 1.1 –

Altman Z-Score and limiting real world factors

In our first Altman Z-Score article we already outlined that while the Altman Z-Score is quite reliable to make proper judgments on the financial shape of a PV manufacturer, there are of course many more and local factors that can come into play in the wake or aftermath of a bankruptcy of a manufacturer.

Such factors can be of strategic importance for a manufacturer, number of people employed, unique technologies or intellectual properties, shareholder interests and so on.

Exemplifying the case of China (but also of course applicable to other countries), companies with strategic importance to (local) governments, are likely to enjoy some degree of support when filing for bankruptcy.

 

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