Also, the G score only predicts whether corporate failure is likely to occur in the next two years, one of which has already
elapsed. It therefore is able to predict corporate failure for only a relatively short amount of time.
The individual weighting of the elements of the score may not be relevant to Gaddon. The model was developed by academics at JSB and is specific to companies in Jayland. It is, however, based on statistical analysis of all companies quoted on the Jayand stock exchange. This will include companies operating in quite different sectors to Gaddon, such as manufacturing and banking, which might make it misleading to apply to a gymnasium operator.
The published accounts of companies approaching corporate failure may be more subject to manipulation and creative accounting than other companies. This may limit the usefulness of calculating the G score, though there is no evidence for this happening at Gaddon.
The calculation of the G score alone may be insufficient to predict corporate failure, and further analysis such as cash flow analysis, or evaluation of the external environment, may be required as well. In particular, the G score is most predicative when the score is low or high. There is a grey area where the G score is between 4 and 6, where no clear prediction is made as to the probability of corporate failure.
A commonly used measure of liquidity is the current ratio, which is the current assets divided by the current liabilities. The current ratio has also deteriorated significantly 3·85:1 （（1,620 + 1,750）/875） in 20X3 to 1·88:1 （（2,585 + 195）/1,475） in 20X4. This means Gaddon is less able to pay its current liabilities as they fall due. Used alone, the current ratio is not a good indicator of corporate failure as it assumes the company can liquidate all its current assets to pay creditors, which is not true in reality.
It is unclear what customers’ payment terms are, though it is likely that they either pay in advance or as they use the gymnasiums. Gaddon is unlikely to have difficulty converting its revenue into cash, which would be another indicator of corporate failure. Instead, the negative free cash flow arises from negative operating profitability and high interest costs.
Another important indicator of liquidity to assess whether Gaddon is at risk of corporate failure is its interest cover ratio; that is the relationship between the operating cash flows of the business and its interest payments. In 20X4, the interest cover is 0·175 （（–1,790 + 2,000）/1,200）, which is very low. An interest cover below the range of between 2 and 5 is a strong indicator of corporate failure.
A much better predictor of corporate failure is the ratio of free cash flow to total non-current liabilities. In 20X3, this was 38:1
（3,800/100） and in 20X4, it was –0·13 （–3,200/24,000）. This is a significant decrease. Having a negative free cash flow, Gaddon is already defaulting on its debt payments and breaching loan covenants with its lenders. Without the continuing support of lenders, Gaddon will be unable to avoid corporate failure.
As the company has missed the July and August 20X5 instalments on the loan repayments, it seems that the liquidity is continuing to deteriorate, and this must indicate a high probability of corporate failure. Even if Gaddon were to become profitable again in the future, without sufficient cash the company may continue to breach lenders’ covenants and will be unable to pay lenders and creditors, who may eventually force the company into liquidation.
The liquidity indicators calculated, together with the negative operating profit in 20X5, do therefore indicate that Gaddon is close to corporate failure and is probably only able to continue trading because of support from its lenders.
