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terms of sales, service or credit contracts with customers; recording information about the financial status of customers and collection efforts; and receiving payments and posting amount paid to customer accounts. Average compensation for this title at midsize organizations ranges from a high of $55,000 in Massachusetts/Connecticut and New Jersey/Philadelphia (Tables 1 and 4) to a low of $37,000 in DC/Virginia/Maryland (Table 7). Again, the variance between the high and low end of the pay scale is significant. For example, at a large company in Minnesota, this title earns $41,000 on the low end and $61,000 on the high enda 33 percent differential (Table 3).

ing systems, carrying out billing, collection, and reporting activities according to specific deadlines. This title also performs reconciliation of accounts, maintains AR customer files, prepares bank deposits, and communicates with customers. In most of the seven geographic regions covered by this survey, the AR clerk earns about the same as a credit and collections clerk. The two exceptions are Massachusetts/Connecticut, where the AR clerk earns fully $9,000 less on average at a midsize company (Table 1) and Florida, where the AR clerk takes home $5,000 less in this category than the credit collections clerk. In Illinois and DC/Virginia/Maryland the AR clerk actually earns $1,000 more on average at a medium-sized company than her or his peer in credit collections (Tables 5 and 7). o

AR Clerk
The accounts receivable clerk typically maintains bill-

How to Calculate Altman Z Score of Customers and Suppliers

By Loral Narayanan In 1968 Edward Altman, a professor at New York University, developed a statistical model designed to provide a basis for improved assessment of customer and supplier creditworthiness and safer investment decisions. Since that time, the Altman Z Score has become a popular method of analyzing a companys health and determining the likelihood of its filing bankruptcy within one to two years. The formula was originally based on data from 66 publicly held manufacturing companies. Half of these had filed for Chapter 7 bankruptcy within the previous two years, and half were going concerns. All 66 companies had assets of more than $1 million. Altman has since developed two additional models: one for privately held manufacturing companies and another for non-manufacturing companies (sometimes called general use companies). risk and corporate health. In its initial tests, the Z Score achieved 72 percent accuracy in predicting bankruptcy within two years. Subsequent testing found the Z Score to be 80 percent to 90 percent accurate in predicting bankruptcy within one year. In general, a deteriorating Z Score signals trouble. Some companies with extremely low historical Z scores, however, have managed to recover and become very successful organizations. An example: Priceline.com had a 2003 Z Score of 0.1, signaling a very high likelihood of failing. The company, however, remained viable. In fact, five years later, its Z Score was at 3.1, which is very much in the healthy range.

Components of the Altman z Score

The Z Score calculation is based entirely on numbers from a companys financial reports. It utilizes seven pieces of data taken from a corporations balance sheet and income statement. Five ratios are then extrapolated from these seven data points. The seven data points, where they are found in a companys financials, and the formula for calculating each one are provided in accompanying Figure 1.
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Accuracy of Altman z Score Statistical Model

It should be understood that the Altman Z Score is not 100 percent accurate. However, it has proved to be one of the best statistical models for determining bankruptcy
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Figure 1. Altman Z: 7 Data Points

Data Point 1) Earnings before Interest & Tax (EBIT) 2) Total Assets 3) Net Sales 4) Market (or Book) Value of Equity 5) Total Liabilities 6) Working Capital 7) Retained Earnings (Source: ABC-Amega)

Where Found in Financials Income Statement Balance Sheet (Total Assets) Income Statement (Net Revenues or Sales) Book Value Found on Balance Sheet (Stockholders Equity) Balance Sheet Balance Sheet Balance Sheet (Stockholders Equity)

Formula to Calculate Gross Earnings - Interest - Income Tax Expense Total Current Assets + Net Fixed Assets (This number in the financials reflects deduction of returns, allowances, and discounts.) Total Market Value (Public Cos.) or Book Value (Private Cos.) of All Shares of Stock Total Current Liabilities + Long Term Debt Total Current Assets - Total Current Liabilities (Portion of net income retained by the corporation rather than distributed to owners/shareholders.)

The five ratios and their descriptions are shown in accompanying Figure 2.

For Non-Manufacturing (General Use) Firms:

Calculating the z Score

To calculate the Z Score, the results of each of the five ratios are multiplied by a set factor (i.e., a coefficient developed by Altman). The results of this multiplication are then added together to determine a companys Z Score. The higher the score, the healthier the company. It is a good idea to compare a companys Z Scores over time to get a better idea as to how the company is doing.

(Because the X5 ratio is believed to vary significantly from industry to industry, that ratio is left out of the Z Score calculation.) Z = 6.56X1 + 3.26X2 + 6.72X3 +1.05X4 Healthy: >2.6 Grey Zone: = 1.10-2.60 Unhealthy: <1.10

where the Altman z Score is Not Reliable

As previously stated, the Z Score is not a perfect predictor. For instance:

For Publicly Held Manufacturing Firms:

Z = 1.23X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5 Healthy: >2.99 Grey Zone: = 1.81-2.99 Unhealthy: <1.81

It will not pick up bankruptcies caused by factors other than those that show up on the balance sheet, such as unexpected business disruptions. It is not immune to false accounting practices (think WorldCom). It is not useful for new companies with little or no earnings. It can change dramatically from quarter to quarter when one-time write-offs are recorded.

For Privately Held Manufacturing Firms:

(Note: in the X4 ratio, replace the market value of equity with the book value.) Z = .717X1 + .847X2 + 3.107X3 + .42X4 + .998X5 Healthy: >2.99 Grey Zone: = 1.23-2.99 Unhealthy: <1.23

Figure 2. Altman Z: 5 Ratios


Description Measures liquidity, a companys ability to pay its short-term obligations. The lower the value, the X1 = Working Capital/Total Assets higher the chance of bankruptcy. Measures age and leverage. A low ratio indicates that growth may not be sustainable as it is X2 = Retained Earnings/Total Assets financed by debt. X3 = EBIT*/Total Assets A version of Return on Assets (ROA), measures productivitythe earning power of the companys assets. *Earnings Before Interest and Tax An increasing ratio indicates the company is earning and increasing profit on each dollar of investment. X4 = Market Value of Equity/Total Measures solvencyhow much the companys market value would decline before liabilities exceed Liabilities assets. (Use the Book value for private firms.) Measures how efficiently the company uses assets to generate sales. Low ratio reflects failure to X5 = Net Sales/Total Assets grow market share. (Source: ABC Amega)
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It is not appropriate for small firms with assets of less than $1 million. It should not be used when studying financial firms, because of their frequent use of off the balance sheet items and financial opacity.

So far, however, the Altman Z Score has proven to be an important tool to help credit professionals analyze corporate health, the possibility of bankruptcy, and overall creditworthiness. A good rule of thumb? Dont rely solely on the Z Score. But do include it in your toolbox of helpful financial analysis models. o
Loral Narayanan is director of marketing at ABC-Amega, editor of the monthly e-newsletter, ABC-Amega Credit-toCash Advisor, and writes educational articles for the companys web site. For more information on outsourcing receivables, visit www.abc-amega.com.

value of the Altman z Score The Z Score does not predict exactly when a firm will file a formal declaration of bankruptcy. What it does do is measure corporate financial stress. It is important to remember, however, that Altman used a relatively small number of companies in the Z Scores development. It is also important to remember that the same Z Score developed more than 40 years ago is still being used today.

Time is Now to Assess Financial Health of Suppliers

Counter-intuitive as it may seem, the initial stages of an economic rebound often pose a greater risk to companies than the worst depths of the preceding crisis. As already weakened organizations start to encounter aggressive competition, the inability of a company to quickly ramp up production to take advantage of new orders and rebuild depleted inventories can become its Achilles heel. If key suppliers are unable to obtain credit or are otherwise too weak to supply critical materials or parts, your organization could be in danger. During the Great Recession, U.S. firms lowered inventory by $207 billion. That spell of inventory reduction is now over, and credit and other executives need to shift gears rapidly.

The Bullwhip Effect

Its now clear that a major challenge for many companies over the next six months is going to be rebuilding inventories to meet booming demand. A particularly striking example of this challenge is illustrated in a recent Wall Street Journal article highlighting Caterpillar Inc. Caterpillar recently informed its steel suppliers that it intends to double its purchases of steel in 2010 over 2009, regardless of its own sales. The same goes for its glass, tire, and other suppliers. Caterpillar executives havent lost their minds; they are anticipating the bullwhip effecta phenomenon that occurs when even small rises in demand result in a significant snap further down the supply chain. The effect is produced because companies are not only filling new orders but also restocking inventory for anticipated future sales. For example, a production boost of 10 percent or 15 percent can require a boost of 30 percent to 40 percent by suppliers.

Role of Credit
Today, credit executives wear more hats than ever in taking on cross-functional responsibilities. When it comes to a companys critical suppliers, for example, it is typically credit (which already has the necessary expertise) that is tasked with assessing suppliers financial health. It may even become necessary to take creative steps to guarantee the flow of critical parts and materials from a supplier by helping to finance its production. One example would be to locate a bank to extend credit against the suppliers receivables so the supplier can be paid faster than the standard 60 days. Decisions like these clearly fall into the bailiwick of the credit department.
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How Healthy Are your Suppliers?

Key suppliers may be starved for credit to rehire and ramp up productionand some of their suppliers may face similar problems. Its critical to know exactly what situation your company faces in this regard. Remember that the absence of a single critical item can bring an entire assembly line to a stop.
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