# Ohlson's O-Score

The Ohlson score, also known as the Ohlson O-score, is a financial model developed by James Ohlson in 1980 as a way to predict the probability of a company's financial distress or bankruptcy. The model is based on financial ratios and accounting data, and it has been widely used by investors and analysts as a tool for evaluating the financial health and risk of a company.

The Ohlson score calculates a numerical score with higher scores indicating higher probability of financial distress or bankruptcy. The model uses a logistic regression analysis to estimate the probability of a company going bankrupt within two years based on several financial variables, including profitability, leverage, liquidity, and cash flow.

The specific financial variables used in the Ohlson score can vary, but typically include some or all of the following:

1. Earnings before interest and taxes (EBIT) to total assets ratio
2. Net income to total assets ratio
3. Return on investment (ROI) ratio
4. Cash flow to total debt ratio
5. Market value of equity to book value of total liabilities ratio
6. Current ratio
7. Asset turnover ratio

The Ohlson score is used by investors and analysts to evaluate a company's financial health and potential risk of bankruptcy. Scores close to -1.81 indicate that the company is financially healthy, while scores above 0.5 suggest that the company is at a high risk of bankruptcy.

Example:

Assume we have the following financial data for Company XYZ:

• Earnings before interest and taxes (EBIT) = \$10 million

• Net income = \$6 million

• Total assets = \$50 million

• Total debt = \$20 million

• Market value of equity = \$100 million

• Book value of total liabilities = \$30 million

• Current assets = \$20 million

• Current liabilities = \$10 million

• Sales = \$100 million

Using these financial data, we can calculate the following ratios:

• EBIT/Total assets ratio = \$10 million / \$50 million = 0.20

• Net income/Total assets ratio = \$6 million / \$50 million = 0.12

• ROI = \$6 million / \$30 million = 0.20

• Cash flow/Total debt ratio = (\$10 million - \$6 million) / \$20 million = 0.20

• Market value of equity/Book value of total liabilities ratio = \$100 million / \$30 million = 3.33

• Current ratio = \$20 million / \$10 million = 2.00

• Asset turnover ratio = \$100 million / \$50 million = 2.00

Then we can plug these ratios into the Ohlson score formula, which is: O-score = -6.18 + 1.42(EBIT/Total assets) + 3.28(Net income/Total assets) + 0.998(ROI) + 0.273(Cash flow/Total debt) + 1.10(Market value of equity/Book value of total liabilities) - 1.02(Current ratio) + 0.296(Asset turnover)

In this example, the Ohlson score for Company XYZ would be: O-score = -6.18 + 1.42(0.20) + 3.28(0.12) + 0.998(0.20) + 0.273(0.20) + 1.10(3.33) - 1.02(2.00) + 0.296(2.00)

O-score = 1.26

A score close to -1.81 indicates that the company is financially healthy, while a score above 0.5 suggests that the company is at a high risk of bankruptcy. Therefore, Company XYZ's Ohlson score of 1.26 suggests that the company is at a high risk of financial distress or bankruptcy within the next