Z-Score
What it is:
The Z-score is a financial statistic that measures the probability of bankruptcy.
How it works/Example:
The Z-score is used to predict the likelihood that a company will go bankrupt. A company's Z-score is calculated based on basic indicators found on its financial statements (e.g. earnings, assets, liabilities, equity, etc.). Lower and negative Z-scores indicate a higher likelihood that a company will go bankrupt, whereas higher and positive scores indicate that a company will survive.
To illustrate, suppose company XYZ is given a Z-score of 3 and that company ABC is given a Z-score of 1. Of these two, company ABC has the greater likelihood of going bankrupt.
Why it matters:
The Z-score serves as a critical indicator of a company's financial health and likelihood to survive. Therefore, the Z-score is important in auditing as well as analyzing credit.