Probably the most famous method of calculating credit risk is the Z Score.
The Z-Score was developed in 1968 by Dr. Edward I. Altman, Ph.D., a financial economist and professor at New York University’s Stern School of Business.
The Z-Score bankruptcy predictor combines five common business ratios, using a weighting system calculated by Altman to determine the likelihood of a company going bankrupt. It was derived based on data from manufacturing firms, but has since proven to be effective as well (with some modifications) in determining the risk a service firm will go bankrupt.
The results indicated that, if the Altman Z-Score is close to or below 3, it is wise to do some serious due diligence before considering investing. The Z-score results usually have the following “Zones” of interpretation:
- Z Score above 2.99 -“Safe” Zones. The company is considered ‘Safe’ based on the financial figures only.
- 1.8 < Z < 2.99 -“Grey” Zones. There is a good chance of the company going bankrupt within the next 2 years of operations.
- Z below 1.80 -“Distress” Zones. The score indicates a high probability of distress within this time period.
There are different veriosn of the Z Score http://www.exceluser.com/tools/zscore.htm
There are other credit risk assessment models too
Credit Analyzer has free calcultors for:
Simple Logit Model
S&P Median Value Model
Private Company Model
What method do you use to assess credit risk?
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