What is the Kaplan-Zingales (KZ) index?
The KZ index is a relative measure of a company’s dependence on external financing.
KZ Index = -1.001909 x Cash flows / K + 0.2826389 x Q + 3.139193 x Debt / Total capital + -39.3678 x Dividends / K + -1.314759 x Cash / K
- Cash Flows = (Income before extraordinary itemst + Total depreciation and amortizationt )
- K = Property, Plant, and Equipmentt-1
- Q = (Market capitalizationt+ Total shareholder's equityt- Book value of common equityt- Deferred tax assets) / Total shareholder's equityt
- Debt = Total long term debtt+ Notes payablet+ Current portion of long term debt
- Dividends = Total cash dividends paidt(common and preferred)
- Cash = Cash and short-term Investmentst
Note that the model is a probabilistic model, so it will not perfectly predict which companies are financially constrained and which are not. In any case, it should help raise warning flags.
What does the KZ index mean?
The higher the KZ index, the more difficult the financial situation will be for a company when financial conditions worsen, as they may have difficulty financing current activities.