Ohlson O-score

The O-score is similar to the Z-score and it can be characterised as a statistical bankruptcy index set up from a set of balance sheet  quotas. The difference from Altman’s original lies in its utilisation of a much larger sample of corporate successes and failures to update the model. The range of over 2000 companies provides it with a more robust sample to base the scaling factors applied to its 9 variables in order to increase its accuracy. The sample size difference is especially evident when compared to Altman’s original whose statistical approach of pair matching limited him to just 66 companies (which is surprisingly successful as it is). Consecutive studies have found that the O-score is a much better forecaster of bankruptcy than the Z-score, however none of them have been able to beat Merton’s DD or the CHS model since their introduction.

Adjusted Size - is the company’s total assets adjusted for inflation. Smaller companies are presumed to be more failure-prone than the others.

AS = log(Total assets/GNP price-level index)
Where GNP price-level index = (Nominal GNP/Real GNP)*100

Leverage Measure - is designed to capture the liability of a company, i.e. the level of dept the company is in. The bigger the LM, the more the company is at risk to shocks.
LM = Total liabilities/Total assets

Working Capital Measure - A company must have enough liquidity  to account for short-term dept and upcoming operational expenses in order to avoid bankruptcy.

WCM =  Working capital/Total Assets

Inverse Current Ratio - Another measure of a company’s liquidity.

ICR = Current liabilities/Current assets

Discontinuity Correction for Leverage Measure - A dummy variable equal to 1 if the total liabilities exceed total assets, otherwise 0. The negative book value in a company is an extraordinary case so Ohlson introduced this additional variable to modify the extreme leverage position.

Return on Assets - A measure of how successful a company is in terms of profit, assumed to be negative for a bankrupt company.

ROA = Net income/Total Assets

Funds to Debt Ratio - A measure of a company’s capability to finance its debt using its operational income alone. FTDR is a conservative ratio since it does not incorporate other sources of cash.If the ratio of funds from operations to short-term debt is than 1, the company could have an immediate problem.

FTDR = Funds from operations/Total liabilities
Where Funds from operations = pretax income + depreciation


Discontinuity Correction for Return on Assets - A dummy variable equal to 1 if income was negative in the last 2 years, 0 otherwise.

Change in Net Income - Was designed to account for any potential continuous losses over the most recent spans of the company history.
CINI = (Net income(t) - Net income(t-1)) / (Net income(t) + Net income(t-1))