It's no secret that the past 12 to 24 months have been especially difficult for many printing companies.  Dr. Joe Webb is estimating that the printing industry lost 2,844 firms in 2009.  Bankruptcies, foreclosure auctions, and other closures have been well documented by WhatTheyThink as well as by other trade publications.

Having a clear picture of your company's financial health is always important, but it becomes essential when business conditions are difficult and the margin for error is reduced.  And while no single tool or formula provides a complete picture of financial health, one popular measure is known as the Z Score.

The Z Score was developed in 1968 by Edward Altman, a financial economist and professor at NYU.  The original objective was to provide a way to assess creditworthiness.  Since that time, the Z Score has become a popular method of analyzing a company's financial health and estimating the short-term risk of bankruptcy.

The Z Score isn't perfect, but when it was initially tested, it was found to be 72% accurate in predicting bankruptcy within two years.  Subsequent testing found that the Z Score was 80%-90% accurate in predicting bankruptcy within one year.

The Z Score combines five common financial ratios.  Each of these ratios is multiplied by a weighting factor developed by Professor Altman.  The values obtained are then added together to determine the Z Score.

The specific ratios and weighting factors for privately-held manufacturing firms are shown below:

  • (Working Capital / Total Assets) X 0.717

  • (Retained Earnings / Total Assets) X 0.847

  • (EBIT / Total Assets) X 3.107

  • (Book Value of Equity / Total Liabilities) X 0.420

  • (Net Sales / Total Assets) X 0.998

A Z Score of above 2.90 indicates that bankruptcy is not likely.  A score that is lower than 1.23 indicates that bankruptcy is a strong possibility.

Your Z Score should be calculated on a quarterly basis as one part of a comprehensive review of your company's financial performance.  This quarterly financial health "check-up" needs to become a standard component of your management routine.  As I noted earlier, when times are tough and the margin of error is small, it's more important than ever to monitor the financial health of your company in a thorough way, on a regular basis.

If you don't have the time or resources in-house to perform this kind of financial review, you should consider getting assistance.  It doesn't have to be costly or disruptive, and with online collaboration tools, it can usually be handled remotely.

I've created an Excel-based Z Score Calculator.  If you'd like a copy of this worksheet, e-mail me directly at ddodd(at)pointbalance(dot)com.