QualityZ-Score#46

Net Margin Trend 5Y

A bankruptcy prediction model that combines five financial ratios into one score. Above 3.0 is the safe zone. Between 1.81 and 2.99 is the grey zone with some risk. Below 1.81 signals high bankruptcy risk within two years.

Formula

1.2(WC/TA) + 1.4(RE/TA) + 3.3(EBIT/TA) + 0.6(MktCap/TL) + 1.0(Sales/TA)

Description

Edward Altman's bankruptcy prediction model, published in 1968. It combines five financial ratios into a single score that predicts the probability of corporate bankruptcy within two years. The model was originally developed using manufacturing firms but has been adapted for other sectors.

Interpretation

Above 3.0: Safe zone. 1.81-2.99: Grey zone with some risk. Below 1.81: Distress zone with high bankruptcy risk. Originally designed for manufacturing companies, so interpret cautiously for banks, utilities, and service firms.

Related Quality Indicators

Return on Equity (ROE)Op Margin

The percentage of revenue left after paying all operating expenses but before interest and taxes. This shows how efficiently the core business runs. Above 15% is generally strong. Consistently expanding margins signal improving business quality.

Return on Assets (ROA)Net Margin

The percentage of every revenue dollar that becomes bottom-line profit after all expenses. Above 10% is strong for most industries. Persistently high net margins often indicate a company has a competitive moat protecting its business.

Return on Invested Capital (ROIC)EBITDA Margin

Profitability before the effects of debt, taxes, and depreciation. Useful for comparing companies across different tax jurisdictions and capital structures. Above 20% is generally strong. Often used in merger and acquisition analysis.

Return on Capital Employed (ROCE)FCF Margin

The percentage of revenue that converts to free cash flow. This is arguably the most honest profitability metric because free cash flow is difficult to manipulate. Above 10% is strong. Capital-light businesses like software companies tend to have the highest FCF margins.

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