The company (Cao, 2016). In other word, it

The Altman Z-score model is a
quantitative formula designed by Edward Altman. It is adopted by public or
private companies to measure a financial health and worthiness of a company (Cao,
2016). In other word, it is a financial model to anticipate the likelihood of
financial distress. It consists of five financial analysis ratios to determine
the probability of bankruptcy among companies by using some basic terms in
financial statements such as assets, liabilities, equity, earnings and others (InvestingAnswers,
2017). Altman Z-score has two outcomes which is positive and negative
indicators. If the company has a Z-Score that is positive and above 3.0, it
indicates that the likelihood of bankruptcy of a company is small and unlikely
to go for bankrupt is low. Oppositely, if the Z-Score of a company is below 1.8
or negative, it indicates the higher probability that a company will go bankrupt
(Rouse, 2014). In summary, the higher the Altman Z-score, it is better for a
company. 

1.      Current ratio

The current ratio is a liquidity
ratio to evaluate the ability of a company to pay its short-term obligations
based on its current assets when they become due within a year. It is also
known as working capital ratio. It is a famous method that used by companies to
determine the short-term solvency position in business (Accountingformanagement,
2012). In others word, it measure the adequacy of current assets to meet its current
liabilities to determine whether it has sufficient resources to pay for its
debt in 12 months. In business, the higher the current ratio is better and
considered as a positive sign for a company. It shows that the company is more
capable to pay its obligations and no short-term liquidity problems. Commonly,
2:1 is considered as a comfortable and acceptable level for all companies (CCD
Consultants, 2015). However, if the current ratio is too high which is more
than 2, it indicates that the company is not efficient in using its current
assets. Oppositely, the current ratio that is less than 1.1 indicates the
company is having the financial difficulty in meeting its current obligations (Peavler,
2017).

2.      Quick ratio

Quick ratio is also known as acid
test ratio, indicates the short-term liquidity of a company. It measures the
relationship between quick assets and current liabilities which evaluates the
ability of a company to utilize its quick assets such as cash, marketable
securities, and accounts receivable to settle its short-term liabilities (Borad,
2017). For a business, the ideal quick ratio is 1:1. It shows that the company
is able to meet its current debt obligations by using its current cash on hand (CCD
Consultants, 2015). However, the company should not keep too much cash on hand
because indicates the company does not use the cash on hand effectively. In
contrast, the quick ratio that is less than 1:1 indicates that the company is
having financial difficulty and does not have enough cash on hand to cover its
short-term debt obligations.

3.      Debts to Total Assets

The debts to total assets ratio is
used to determine the portion of a company’s assets that are financed by debt
financing rather than the equity financing. In other words, it is a financial
leverage ratio to shows a total assets’ percentage of a company that was
financed by debt, lenders, and creditors instead of funded from investors (Averkamp,
2017). If the ratio is above 1%, it means that the company is facing trouble
because of borrowing too much funds from creditors and lenders. The company is
putting itself at risk of unable to pay its backs on time to creditors as well
as bankruptcy (Peavler, 2017). Oppositely, if the ratio is lower than 1%, it
shows that the company is borrowed little funds from debt financing as compared
to total assets. The low ratio indicates that most of the funding is from
equity financing and signals a stability if a company (Borad, 2017).

4.      Debts to Equity

The debts to equity ratio is also
known as gearing ratio which measure the weight of total debt of a company
against the total equity of a company. The ratio shows the company percentage
of financing that arises from creditors rather than investors financing (My
Accounting Course, 2017). Generally, a high percentage of debts to equity which
is more than 50% indicate that there is greater risk of insolvency and bankrupt
faced by the company and unable to generate adequate cash to pay off debt
obligations (InvestingAnswers, 2017). In contrast, the low ratio or less than
50% signals that the company adopts a more financially stable business which
the assets portion provided by shareholders or investors is greater than
creditors (Accountingformanagement, 2017).

 

5.      Operating Cash Flow to Total
Liabilities

Operating cash flow to total
liabilities ratio is used to measure the cash generated from the ordinary
course of business. Generally, it is adopted by the company to determine the
ability to pay its liabilities and its liquidity position (Bragg, 2014). If the
ratio is 1 and above, it is within the acceptable range which indicates the
liquidity position of the company is better. Also, the company’s financial
flexibility is better and able to pay its liabilities. Oppositely, if the
operating cash flow to total liabilities is below 1, it shows that the company
is unable to cover its current liabilities by the operating cash flow
generated. Moreover, it indicates that the company has financial distress
(Accounting Capital, n.d.) In summary, the higher the operating cash flow to
total liabilities is better.

6.      Interest Coverage ratio

Interest coverage ratio is used to
measures the ability of a company to make interest payments on debts in a
timely manner. In other words, the interest coverage ratio is adopted by the
company to determine the numbers of times that could make on the payments on
interest on its debt with the earnings before interest and taxes (EBIT) (Bragg,
2017). If the ratio is greater than 1, it indicates that the company is able to
pay the interest expenses with sufficient funds and there is still has additional
earnings for the principles payments. However, if the ratio is less than 1, it
shows that the company is unable to make payments on interest due to
insufficient funds. Thus, the higher the interest coverage ratio is better for
a company (MyAccountingCourse, 2017).