By the end of a financial analysis, readers must be able to answer the following two questions that served as the starting point for their investigations:

• Is the company solvent? Will it be able to repay all its creditors in full?

• Is the company creating any value for its shareholders?

A company is solvent when it is able to honour all its commitments by liquidating all of its assets, i.e. if it ceases its operations and puts all its assets up for sale. Solvency depends on the break-up value of a company’s assets, and the size of the debts. Net assets, i.e. the difference between assets and total liabilities, are the traditional measure of a company’s solvency.

A company creates value if the return on capital employed (after tax) that it generates exceeds the cost of the capital (i.e. equity and net debt) that served to finance capital employed.

Lastly, we recommend that readers who need to carry out a rapid assessment of an ailing company where the accounts are not yet available build a cash flow statement in reverse. This reverse approach starts with reduction in net debt and works back towards net income, thus gauging the scale of losses that put the company’s solvency and very survival in jeopardy.