This tool is a quantitative measure derived from a formula that uses multiple corporate income statement and balance sheet values to predict the probability of a company entering bankruptcy within a two-year period. It generates a single number indicating financial health, with a lower score suggesting a higher risk of distress. For instance, a score below 1.8 generally indicates a company is likely headed for bankruptcy, while a score above 3.0 suggests financial stability.
Its significance stems from providing a readily understandable gauge of a business’s financial solvency, assisting investors, creditors, and management in evaluating risk. Its development revolutionized financial analysis by offering a more comprehensive and objective assessment compared to relying solely on individual financial ratios. Historically, it has been applied widely to assess the financial stability of manufacturing firms, subsequently adapted and modified for use across various sectors and economies.
