Introduction
The Altman Z-Score is a great bankruptcy prediction tool for investors. Investors and analysts worldwide use it to check if a company is financially healthy or heading toward trouble. But this model was designed for old-school manufacturing companies. Some experts say that it is not suitable for today’s tech-driven businesses like Zomato, Paytm, or Lenskart.
If you blindly apply the Altman Z-Score to these modern companies, you might get misleading results.
Let me explain why this happens and what better options you have.
What is the Altman Z-Score?
Before we dive into the problems, let’s quickly understand what the Altman Z-Score actually does. Professor Edward Altman created this formula using five financial ratios:
- Working Capital / Total Assets (WCTA) – Measures short-term liquidity
- Retained Earnings / Total Assets (RETA) – Shows accumulated profits
- EBIT / Total Assets (EBITTA) – Indicates operating efficiency
- Market Value of Equity / Total Liabilities (MCAPTL) – Represents financial leverage
- Sales / Total Assets (STA) – Measures asset turnover
The original formula multiplies these ratios by specific weights and adds them up.
A score above 2.99 means the company is safe. Between 1.81 and 2.99 is the grey zone. Below 1.81 signals high bankruptcy risk.
Sounds straightforward, right? But when you apply this to tech companies, things are not as clear.
Why the Altman Z-Score Fails for Tech Companies
Problem 1: Negative Working Capital Doesn’t Mean Trouble
Zomato and Paytm often show negative working capital. What does it mean by negative working capital?
It means, their current liabilities exceed current assets.
In traditional manufacturing, this would be a red flag. But for food delivery and payment platforms, it’s actually normal.
These companies collect money from customers instantly but pay restaurants and merchants later. They hold customer cash as a liability, which creates negative working capital. When you add money to your Zomato wallet or Paytm wallet, that money sits with the company but doesn’t belong to them, right? It’s your money.
On the balance sheet, this customer cash appears as a liability (an obligation to pay you back) rather than actual revenue or profit. So even though Zomato and Paytm have billions in their bank accounts, most of it isn’t theirs to keep, it’s held in trust for customers.
This creates negative working capital because their current liabilities exceed their current assets (money actually available for operations). But for these companies, this isn’t a sign of trouble. It’s actually a business feature. They get to use your money interest-free for a few days before paying restaurants or merchants. This actually improves their cash flow and reduces the capital they need to borrow.
Traditional manufacturing companies don’t have this benefit. As Altman Z-Score was built considering traditional manufacturing companies as examples, they treats negative working capital of E-commerce companies as a red flag.
But for these platform companies, it’s completely normal and even healthy.
Problem 2: Startup Losses Create Negative Retained Earnings
Lenskart showed losses of Rs. 102 crore in FY2022 and Rs. 64 crore in FY2023 before turning profitable with Rs. 297 crore profit in FY2025.
Paytm has been burning cash for years, reporting losses of Rs. 14,224 crore in FY2024.
These accumulated losses show up as negative retained earnings on the balance sheet.
The Z-Score formula heavily punishes this, even though these companies are deliberately investing in growth rather than booking net profits.
The point is, I think, the Altman Z Score’s model is code framed that it cannot distinguish between a struggling business and a fast-growing startup.
Problem 3: Asset-Light Business Models Confuse the Formula
Tech platforms like Zomato don’t own restaurants. Paytm doesn’t own bank branches. Lenskart is increasingly franchising stores rather than owning them.
What does this information tell about them? These are asset-light business models.
The Altman Z-Score was designed when businesses needed heavy machinery, factories, and inventory. Modern tech companies generate massive revenue with minimal physical assets.
Their real value lies in software, brand, and network effects. They are all intangible assets that don’t appear properly on balance sheets.
The Sales/Total Assets ratio (STA) becomes artificially high for these companies, distorting the entire calculation.
Problem 4: High Intangible Asset Intensity
Technology and pharmaceutical companies have very high intangible asset intensity – like patents, software, algorithms, and brand value.
The Altman Z-Score doesn’t properly capture this value, leading to inflated or deflated scores.
For example, Lenskart’s real value is in its omni-channel retail technology, brand recognition, and customer data. They are not known for physical stores or huge inventory buildups.
How These Companies Would Score
Let’s see what actually happened with these companies:
Zomato: Showed continuous losses from FY2019 to FY2023. The company posted negative ROE of -97.44% in FY2021. The Altman Z-Score would have flagged it as heading toward bankruptcy. But in FY2024, Zomato posted its first profit of Rs. 351 crore, with operating profit of Rs. 889 crore and a debt-free balance sheet. The company is now, comparatively, financially healthy and growing. This is alter to what the Altman Z-score would have been saying only a couple of years back.
Paytm: Despite regulatory challenges and continued losses, Paytm has over Rs. 170 billion in short-term assets covering its liabilities. The company is debt-free with more cash than total debt. The Z-Score would miss this positive liquidity position while focusing on accumulated losses.
Lenskart: The Z-Score would have shown distress during FY2022-FY2024 when the company was making losses. But this was strategic investment in expansion. FY2025 revenue jumped 22.5% to Rs. 6,652 crore with a net profit of Rs. 297 crore. The business model, I think, has proved its sustainability. But the Z-Score couldn’t predict this turnaround.
Are There any Better Alternatives for Modern Businesses?
Instead of relying only on the Altman Z-Score, here are better tools for evaluating tech companies:
- Piotroski F-Score: This is a 9-point checklist that gives each company a score from 0 to 9. It evaluates profitability, liquidity, and operating efficiency using simple yes/no questions. Studies show it can predict financial distress with 79.2% accuracy. It’s particularly good at identifying distressed stocks showing turnaround potential.
- Ohlson O-Score: Created in 1980, this model uses 9 variables including cash flow from operations and considers timing of information release. It was built using over 2,000 companies compared to Altman’s 66. This makes it more statistically robust. The O-Score achieved over 90% accuracy in bankruptcy prediction. The key advantage? It includes funds from operations and considers whether a company had losses for two consecutive years. It is much more relevant for startups.
- Modern SaaS and Platform Metrics: For technology and platform companies, investors now focus on entirely different metrics:
- Burn Rate and Cash Runway: How fast is the company spending cash, and how many months can it survive? Zomato had Rs. 12,241 crore cash in FY24. Paytm’s operating cash flow turned positive with Rs. 386 crore in FY25.
- Customer Acquisition Cost (CAC) vs Lifetime Value (LTV): Is it cheaper to acquire customers than the revenue they generate? A healthy ratio is 3:1 or better.
- Gross Merchandise Value (GMV): For marketplaces like Zomato, GMV measures total transaction value flowing through the platform. Though it doesn’t equal profit, rising GMV indicates growing business scale.
- Rule of 40: For SaaS companies, the sum of revenue growth rate and profit margin should exceed 40%. What does it mean? A company growing at 50% can even afford a negative margins upto -10%. One growing at 20% will need 20% margins. This balances growth and profitability.
- Net Revenue Retention (NRR): Are existing customers spending more over time? High NRR reduces dependence on new customer acquisition.
- Cash Flow-Based Models: Several studies show that cash flow ratios predict bankruptcy better than traditional accrual-based ratios. Models using operating cash flow to total liabilities, or cash flow to total debt, can predict failure five years ahead. For example, Zomato’s cash flow from operations improved from -Rs. 844 crore in FY23 to +Rs. 646 crore in FY24. This positive cash generation is a better health indicator than accumulated losses.
What Should You Do as an Investor?
Don’t throw away the Altman Z-Score completely.
It still works well for traditional manufacturing and asset-heavy businesses. But for technology, e-commerce, and platform companies, follow this approach:
- Use the Z-Score as a starting point, not the final answer. If a tech company shows a low Z-Score, investigate why. Is it negative working capital due to business model? Or real financial trouble?
- Focus on cash flow trends. Is operating cash flow improving quarter-over-quarter? Zomato went from burning Rs. 844 crore to generating Rs. 646 crore in one year. That’s a massive positive signal.
- Check unit economics. Can the company make money on each transaction? Or are they losing money on every sale hoping to make it up in volume?
- Evaluate the path to profitability. Lenskart showed a clear trend. Its losses narrowed from Rs. 102 crore to Rs. 64 crore to Rs. 10 crore before turning profitable. That’s strategic. Random fluctuating losses are concerning.
- Compare with peers (but not with manufacturing companies). Zomato should be evaluated against Swiggy, not against Tata Steel. Different business models have different financial patterns.
- Look at liquidity separately from profitability. Paytm has strong liquidity with Rs. 170 billion short-term assets, even while showing losses. This distinction is important to judge new age technology companies.
Conclusion
The Altman Z-Score was brilliant for its time and still has value for traditional businesses. I strongly beleive it hence it’s been a integram part of my Stock Engine’s algorithm.
But applying it blindly to Zomato, Paytm, or Lenskart type companies is like using a thermometer to measure blood pressure.
You’re using the wrong tool for the job.
Modern tech companies operate on entirely different principles:
- Negative working capital by design,
- Intentional losses during growth phase,
- Asset-light models, and
- Intangible value creation.
The Z-Score wasn’t built to understand these dynamics.
Smart investors will combine multiple tools like below:
- Overall Health Check: Piotroski F-Score,
- Bankruptcy probability: Ohlson O-Score,
- Growth Stocks: modern SaaS metrics for , and
- Cash flow analysis for everyone.
Expert investors will also add qualitative factors like management quality, competitive moat, and market opportunity.
It is important to remember that no single metric tells the complete story. Financial analysis is about building a complete picture.
The companies that looked “doomed” by Z-Score standards, like Zomato with its years of losses, can turn profitable when the business model matures.
The key is understanding which losses are strategic investments and which are genuine distress signals.
Have a happy investing.
