ALTMAN’S MULTIVARIATE MODEL

Altmans multivariate model uses five ratios and developed a

discriminant score called Z score for predicting the future.

i. Working capital/ total assets

ii. Retained earnings/total assets
iii. EBIT/ total assets
iv. Market value of equity/ book value of debt
v. Sales/ total assets.

Z score is calculated as follows

Z= 1.2 x1+ 1.4x2 + 3.3 x3 + 0.60 x4 + 1x5
X1 = working capital/ total assets
x2 = Retained earnings/total assets
x3 = EBIT/ total assets
x4= Market value of equity/ book value of debt.
x5 = Sales/ total assets.

According to Altman’s a firm with a score of above 2.7 is

financially strong and a firm with a score less than 2.7 has the
profitability of a financial failure.

PROFITABLITY RATIOS
Profitability ratios are utmost importance for a concern. These
ratios are calculated to enlighten the end results of business
activities which are the sole criterion of the overall efficiency of a
business concern.

1.NET PROFIT RATIOS

This ratio is very useful to proprietors investors because it
reveals the overall profitability of the concern. This is the ratio of the
net profit after taxes to net sales and is calculated as follows

Net profit ratio= higher the ratio, the better it is because it gives
idea of improved efficiency of the concern.
2. operating profit ratio
 This ratio establishes the relationship between operating profit
and sales and is calculated as follows

Operating profit ratio = operating profit / net sales * 100

This ratio indicates the portion of remaining out of every rupee

worth of sales after all operating costs and expenses have been met.
Higher the ratio the better it is.

3. EXPENSES RATIO
Material consumed ratio
This ratio is calculated to ascertain the relationship that exist
between operating expenses and volume of sales. This ratio is
calculated as follows :
Material consumed ratio = material consumed / net sales * 100

4. RETURN ON CAPITAL EMPLOYED(OVERALL PROFITABILITY RATIO )

This ratio is an indicator of earning capacity of the capital
employed in the business. The ratio is calculated as follows :
Return on capital employed = operating profit/ capital employed
*100
This ratio reflects the overall efficiency with which capital is used.

5. RETURN ON EQUITY
This ratio is a measure of the percentage of net profit to equity
shareholder’s funds. The ratio is expressed as follows
Return on equity = net profit after interest, tax and preference
dividend/ equity share holders fund * 100
6. RETURN ON TOTAL ASSET
This ratio is calculated to measure the profit after tax against the
amount invested in total assets to ascertain whether assets are
being utilised properly or not. It is calculated as follows :
Return on total asset = net profit after taz/ total asset * 100
7. EARNINGS PER SHARE
This ratio indicates the amount of earning per share. It is
calculated as follows :
 Earning per share = net profit after tax and preference dividend/
number of equity share * 100
A growth company is one, the EPS of which increases year after
year.

8. dividend payout ratio

This ratio is proportion od dividend per common share to earning
per share.
Dividend payout ratio= dividend per equity share/ earning per
share.
This ratio is very important from share holders point of view as it
tells him that if a company has used whole or substantially the whole
of its earning for paying dividend and retained nothing for future
growth and expansion purpose, then there will be very dim chance of
capital appreciation in the price of shares of such company.

ACTIVITY RATIOS

These ratios are very important for a concern to judge how well
facilities at the disposal of the concern are being used or to measure
the effectiveness with which a concern uses its resources as its
disposal. These ratios are usually calculated on the basis of sales or
cost of sales and are expressed in integers rather than as a
percentage.

1. CAPITAL TURN OVER RATIO

This ratio shows the efficiency of capital employed in the
business by computing how many times capital employed is
turned over in a stated period. The ratio is ascertained as follows
:

Capital turn over ratio = sales/ capital employed

The higher the ratio, the greater are the profits. A low capital
turnover ratio should be taken to mean that sufficient sales are
not being made profits are lower.
2. FIXED ASSET TURNOVER RATIO
 This ratio expresses the number of times fixed assets are being
turned – over in a stated period. It is calculated as under :
Fixed asset turnover ratio = sales / net fixed asset
The higher the ratio, the better is the performance.
3. WORKING CAPITAL REQUIREMENT
This ratio expresses the number of times fixed assets are being
turned – over in a stated period, it is calculated as under :

Working capital turnover ratio = sales/ net working capital

The higher is the ratio, the lower the investment in working
capital and the greater are the profits. However a very high
ratio is sign of overtrading and may put the concern into
financial difficulties. On the other hand, a low working capital
turnover ratio indicates that working capital is not efficiently
utilised.