Priority One
Corporate Self-Assessment

To make plans for the future, you must know where you are in the present. Regent Pacific helps you get started with this time-honored, industry standard, self-assessment  tool designed to help you, your staff, your board and investors analyze the current situation of your organization.

As we note in the Marketplace portion of this Web site, we recognize how difficult it is to consider asking for help from outside your own organization. That's why self-assessment is such an important and powerful first step. Regent Pacific's "bottom up" approach for assessing your company takes advantage of what we've learned in nearly four decades of turnaround management. We know the pitfalls to avoid and the early warning indicators to heed. To that end, we offer this self-assessment tool that can be used with, or without, outside help. Now that may sound a little odd - self-assessment with outside help - but consider that thirty-eight years of expertise can't simply be reduced to a set of analytics and benchmarks. This traditional self-assessment exercise might best be administered with a facilitator from our firm to expedite the process and assure an even-handed implementation and comprehensive assessment. But that is totally your call. Please Contact Us for more information about this program.

Before You Begin: The Altman Z-Score Assessment Tool

One of the quickest ways to ballpark where you are in the "present" is the Altman Z-Score. The five-factor Z-Score model was developed in the late 60's by Dr. Edward I. Altman, a finance professor at New York University's Stern School of Business. The Z-Score combines a set of financial ratios to determine the statistical probability of failure or success for a company. Initially, the Z-Score predictor model was used primarily by passive credit analysts, bankers, and those in academia. It has evolved to become a valuable early-stage assessment tool for operating management and turnaround professionals preceding the implementation of a structured turnaround methodology. Using the calculator below, you can calculate your company's Z-Score right now using your own data from your own balance sheet and income statements (each from the same ending reporting period; income statement information annualized). Any negative entries should br preceded by a (-) minus sign.
Z-SCORE ABOVE 3.0: Based on the figures provided above, your company is safe and financially healthy.
Z-SCORE BETWEEN 2.6 and 2.99: It could be time to bring in a corporate renewal firm to analyze your situation as a matter of caution.
Z-SCORE BETWEEN 1.81 and 2.59: Your company could become insolvent within two years. Bringing in a restructuring, renewal, and interim management firm would be a responsible course of action.
Z-SCORE BELOW 1.80: You could be looking at a statutory reorganization or radical restructuring in the near future. Insolvency within one year is a real possibility. Hopefully, you've already engaged outside help.
The original Altman Z-Score model was based on statistical information and industry data from publicly-traded manufacturing companies. The score was calculated based upon the five-factor component model described below. For non-manufacturing companies, the X5 component varies significantly by industry. It is likely to be higher for merchandising and service companies since they are typically less capital intensive. Altman recommends a slightly different formula to correct for that condition. Also, a somewhat different formula has emerged for private companies to compensate for using "book value of equity" instead of "market value of equity." More information regarding these alternative formulas can be provided if you Contact Us.

It is generally agreed that within each category, a Z-Score above a certain number indicates strong health; a score below a smaller number indicates your company is a bankruptcy candidate; and any score in between those numbers represents the "gray area," and a call for help and caution is advised.

  • For manufacturing companies, Z>3 indicates strong health; Z<1.8 indicates a bankruptcy candidate; thus the gray area is 1.81 to 2.99.

  • For privately-owned companies, the range for the gray area is a little lower: 1.29 to 2.90 to account for the differences between book value and market value of equity.

  • For non-manufacturing companies, the range for the gray area is even lower: 1.1 to 2.60.
Z-Score Components

Understanding the Z-Score requires an appreciation of its components and the relevance of changes in them to the end result. The Z-Score is the sum of five weighted ratios: Z = 1.2(X1) + 1.4(X2) + 3.3(X3) + 0.6(X4) + 1.0(X5) where:

X1 = Working Capital/Total Assets
X2 = Retained Earnings/Total Assets
X3 = Earnings Before Interest and Taxes (EBIT)/Total Assets
X4 = Market Value of Equity/Book Value of Total Liabilities
X5 = Sales/Total Assets

The indicators provide insight into various aspects of a company's finances:

X1. Dividing working capital by total assets measures the net liquid assets of a firm in relation to its total capitalization. Working capital is the difference between current assets and current liabilities.

Many companies that are headed for trouble experience a decrease in working capital. Assets balloon, and funds are spent on nonessential operations. Because the denominator is total assets, a company should focus on reducing its total assets to increase the ratio.

If a firm disposes of fixed assets and other underutilized assets to generate cash, the denominator shrinks. Working capital increases because of the conversion of long-term assets into current assets or decreased liabilities. Some long-term assets have long-term debt attached. Although their sale might not improve the working capital ratio, it would decrease total debt and improve profitability by decreasing interest and depreciation costs. Responsible parties must focus on long-term assets that generate cash. (Selling off assets to reduce cash outflow and debt is typically part of a successful turnaround solution.)

X2. Retained earnings represent the accumulation of earnings that have remained within the entity. Retained earnings can be affected by quasi-reorganizations and stock dividend declarations. If so, consideration should be given to readjusting retained earnings. A young firm will be impaired by this ratio and this should be kept in mind.

To increase retained earnings, a company must generate profits, either through operations or the profitable sell-off of assets or divisions or the forgiveness of debt.

X3. Dividing EBIT by total assets provides an indicator of the productivity of a company's assets and is important because a firm's long-term existence is based upon the earning power of its assets.

Apart from reducing assets in an operating turnaround, it is usually vital that a company decrease costs and become a low-cost producer. As a company reduces its costs and starts to produce profits, its working capital should increase if cash is not spent on capital items or acquisitions. Retained earnings should also increase, assuming no dividends or unnecessary distributions are paid. As the business cycles evolve, cash should start to accumulate.

X4. Dividing the market value of equity by the book value of total liabilities shows how much a firm's assets can decline in value (measured by market value of equity plus debt) before its liabilities exceed its assets and the firm becomes insolvent.

For privately held firms, this factor is calculated as net worth/total debt. This value will be smaller, and the overall Z-Score indicators are adjusted downward to reflect this lower number.

X5. The capital-turnover ratio indicates the sales-generating ability of the firm's assets. It is one measure of management's capacity in dealing with competitive conditions.

In many operational turnarounds, sales fall in the short term as weak customers and product lines are eliminated. The assets should be deployed in sales and profit initiatives for long-term growth. The assets should be deployed in profit-generating activities for the company to segue into the future.

More About Your Company's Z-Score

No model predicts precisely when failure will occur, but the Z-Score has indicated that failure is likely up to two years before a company declares bankruptcy. The Z-Score should be reviewed over time rather than at any one point in time. The trend is important. The most serious changes in the ratios occur between the third and second years prior to bankruptcy.

Using computer simulation models to depict how the turnaround strategy will impact these numbers and the Z-Score is a great way to communicate the action plan to interested parties. Performing a series of what-if analyses on a plan assists in determining what results are required from the asset sell-off to give a company a chance to survive.

The most heavily weighted Z-Score factor is X3, at 3.3. Not surprisingly, returning the company to profitability will have the largest impact on the Z-Score and the company's short- and long-term viability.

Because total assets serve as the denominator in four of the five factors, most companies' action plans should focus on reducing total assets.

Executing the strategy is more difficult than the theory behind the Z-Score. Following a plan that improves the Z-Score helps validate the turnaround plan by providing management with a tool it can understand, buy into, and follow.

Most of the Z-Score data and definitions presented above were extracted from the information presented in Edward I. Altman's book, Corporate Financial Distress and Bankruptcy: A Complete Guide to Predicting & Avoiding Distress and Profiting from Bankruptcy, 2d Ed. (John Wiley & Sons, Inc., 1993). Additional interpretations were extracted from an article, "Using the Z-Score As A Turnaround Tool," The Journal of Corporate Renewal, Turnaround Management Association publication, March 2003.