As an investor a sound assessment of credit risk, the likelihood that your counterparty defaults, is very important. Both to determine whether the risk-return profile of a company still suites your preferences as well as to set your minimum required rate. One of the most commonly known methods used to quantify credit risk is the Altman z-score model.
Original Altman z-score model
The original Altman z-score model quantifies a default indicator z by taking a weighted sum of 5 different ratios as shown below. Originally it was used to measure the credit risk of publicly traded manufacturing companies.
Companies with higher z-scores are viewed as safer, lower z-score companies are riskier. Companies with a z-score larger than 2.99 are categorized as safe. Those with a score below 1.81 are categorized as very risky, meaning a high likelihood of bankruptcy. Those in between the 2 value are closely to monitor companies. Besides the z-score itself, tracking periodical changes in z-scores provides even more information on default risk.
Altman z-score model quantifies the credit risk of a certain company. The higher the score, the safer the company, thus the lower the credit risk.