How to Tell if a Company Might Go Bankrupt
The quickest check on bankruptcy risk is the Altman Z″-Score, which combines four ratios from a company's balance sheet and income statement: above 2.6 is the safe zone, 1.1 to 2.6 the grey zone and below 1.1 the distress zone. It is a statistical warning that has gone with failures within about two years, not a prediction. Check it alongside interest coverage, debt, cash flow and shrinking revenue, since several warnings together matter more than one.
What are the warning signs of bankruptcy risk?
| Warning sign | What to look for | Where to see it |
|---|---|---|
| Distress-zone Z″-Score | Below 1.1 | Altman Z Screener |
| Weak interest coverage | Operating profit under about 1.5 times interest expense | Falling-knife flags on the Mean Reversion Screener |
| High leverage | Debt to equity above 2.0, and well above its sector's median | The same falling-knife flags |
| Weak liquidity | Current ratio under 1.0 | The same falling-knife flags |
| Cash burn | Negative free cash flow year after year | Free cash flow on each stock's page |
| Shrinking business | Revenue down 10% or more year on year | The same falling-knife flags |
Several together are the pattern. The leverage, liquidity, coverage and revenue thresholds are the screener's falling-knife checks, written out in how the Mean Reversion Screener works.
How is the Altman Z-Score calculated?
Z″ = 6.56 × X1 + 3.26 × X2 + 6.72 × X3 + 1.05 × X4
X1 is working capital ÷ total assets, X2 retained earnings ÷ total assets, X3 operating profit (EBIT) ÷ total assets and X4 book equity ÷ total liabilities. Two worked examples, both made up:
| Acme Co. | Beta Co. | |
|---|---|---|
| Total assets | $1,000 | $1,000 |
| Working capital | $150 | -$50 |
| Retained earnings | $300 | -$200 |
| Operating profit (EBIT) | $100 | $20 |
| Book equity / total liabilities | $400 / $600 | $100 / $900 |
| Z″-Score | 3.33 (safe) | -0.73 (distress) |
Acme earns well on its assets and owns more than it owes. Beta has negative working capital and accumulated losses, so its score is well below the 1.1 line. The full method, including why banks, insurers, REITs and utilities are left out, is on how this site computes the Altman Z-Score.
How many tracked stocks are in each zone?
Of the 293 stocks this site tracks, 69 are in sectors the score is not built for, and 39 lack the balance-sheet line items. Of the 185 it can score:
Tracked stocks by Z″-Score zone, from each company's latest 10-K. Banks, insurers, REITs and utilities are not scored.
A large distress count does not mean 40 companies are about to fail. Companies that have spent heavily on buybacks can have low or negative book equity, which drags X4 down, and the score uses year-old balance sheets. A distress reading is a prompt to read the filings, ideally next to the checks in how to check if a stock is a value trap.
Bankruptcy risk FAQ
What is the best indicator of bankruptcy risk?
No single number is. The Altman Z-Score is the most widely used summary of balance-sheet health, and it works best alongside interest coverage, debt, cash flow and the trend in revenue.
What is a bad Altman Z-Score?
On the Z″ version this site uses, below 1.1 is the distress zone and between 1.1 and 2.6 is the grey zone. Above 2.6 is the safe zone.
Does a distress score mean a company will go bankrupt?
No. It means the balance sheet resembles those of companies that failed in the past. Buyback-heavy companies, for example, can score low with strong profits, so read the underlying ratios.
Can a profitable company go bankrupt?
Yes, if it cannot refinance its debt or meet short-term obligations, because profit is not the same as cash. That is why liquidity, interest coverage and cash flow are checked as well.
Why are banks not scored?
Their balance sheets work differently: deposits are liabilities that are not like an industrial company's working capital, so the model was not built for them. This site leaves banks, insurers, REITs and utilities out.