Page 299 - AFM Integrated Workbook STUDENT S18-J19

Corporate failure and reconstruction

Corporate failure and financial distress

1.1 What is corporate failure?

Corporate failure occurs when a company cannot achieve a satisfactory
return on capital over the longer term.

If a company is in financial distress, corporate failure will follow unless
the company's problems can be identified and corrected.

Therefore, it is important that we can recognise the main causes of
financial distress.

1.2 Identifying financial distress

It is possible to identify a business in financial distress by analysing its financial
statements.

 Trends in ratios (such as return on capital employed and receivables collection
period) can be used to identify the first signs of distress.

 Free cash flow analysis can also give an indication of likely problems.

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