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Altman Z Score; Credit Scoring Models
As the requirements for quick decisions by the credit department becomes more critical, credit departments are struggling to keep pace with the need for fast and appropriate decisions. Some credit departments now use decision support softare such as credit scoring models to make the credit decision-making process faster, more efficient and more reliable. A credit score is a number or letter that provides creditors with an assessment of the overall risk of offering a customer open account terms and a specific credit limit. Some creditor companies use credit scoring models to make decisions and release orders. Other suppliers use credit scoring models to help the credit department make these decisions.
The Altman Z Score is one such model. It is a predictive model created by Edward Altman in the 1960s to forecast business bankruptcies within one to two years. This model combines five financial ratios to determine the likelihood of bankruptcy. It is considered by many credit professionals to be a relatively accurate model. Debtor companies with scores of 3 and above are considered to be financially healthy and at low risk for bankruptcy.
In its initial testing, the Altman Z Score successfully predicted 72% of bankruptcies two years prior to the companies filing for Chapter 7 (liquidation) bankruptcy.
(See also "Credit Scoring")
Edited by Michael C. Dennis