DEFINITION of 'Zeta Model'

The Zeta Model is a mathematical formula 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, and is a reasonably accurate predictor of future bankruptcy. The model is specified as:

Formula for calculating the Zeta model.

Where:
Z = Score
A = Working Capital/Total Assets
B = Retained Earnings/Total Assets
C = Earnings Before Interest & Tax/Total Assets
D = Market Value of Equity/Total Liabilities
E = Sales/Total Assets

BREAKING DOWN 'Zeta Model'

The Zeta Model returns a single number, the z-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. 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.

The Zeta Model was developed by New York University professor Edward Altman in 1968. The model was originally designed for publicly traded manufacturing companies. Later versions of the model were developed for privately held companies, small businesses and non-manufacturing companies and emerging markets.

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