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If you want to avoid disasters such as Railtrack and Marconi you'll have to pick up some classic sell signals

Novice investors must think the stock market scarier than ever. Supposedly solid blue chips have recently seen their valuations crumble, making the FTSE 100 look more like a corporate graveyard than a collection of robust companies.

The Government has put Railtrack into administration. National airlines around the world are grounded by their debts. Telecom equipment supplier Marconi has seen its share price fall 99 per cent from its high. And a whole host of other technology companies have had their valuations slashed.

Even worse, some notable quoted concerns have gone bust, among them Independent Insurance, Versailles (amid fraud charges) and Cammell Laird.

Shareholders in such enterprises should be more wary than other connected parties since they are normally last in line to receive any money if a company fails.

So, when cash is tight and making decent returns is harder than in previous years, investors' prime focus should be to conserve their cash. Take a good, hard look at your investments and avoid the ones that look troubled. But how? Here are some signals which should set warning bells ringing.

Look at the books

Most companies collapse because they can no longer pay their debts and creditors refuse to extend their lending agreements. This means they run out of cash and can no longer operate. Do not be dazzled by headline stories of glorious sales growth in the profit and loss account.

Instead turn to the balance sheet, where companies have to confront hard facts. Hugh Hendry, a hedge fund manager at Odey Asset Management, says 'it's harder to lie with this statement'. Here you will find how much the group has borrowed and when it needs to be repaid. More details on a company's debts can normally be found in the notes to the accounts.

Watch out if the value of stocks in the accounts suddenly jump. This indicates that the company cannot shift its products and may have to write some of this off. If creditors have surged this may explain why turnover has grown but could possibly signal trouble ahead.

Beware of dreadful debts

Going back to the profit and loss account will show how much the company has to spend on interest payments. If this is only just covered by the operating profits, you need to worry about the business's health.

If a group's share price has already collapsed then this might make things trickier. Banks and creditors will be unwilling to lend the company more money if its value has dropped. This is the affliction many indebted telecom companies have suffered this year, prompting them to sell assets.

Track the cash

The problem with the balance sheet is that it only gives a snapshot of the financial health of the company on one day. The cashflow statement is much more accurate. As the name suggests this shows what money has flowed in and out of the company over the whole accounting period.

This will tell you if a company actually makes money from its operating activities. It will also detail how the operation has been financed, whether through debt or other financing, such as an issue of shares. It also will show any spending on acquisitions and what money has come from asset sales.

Focus on the business

For many investors a dicey balance sheet and curious cashflow statement may already arrive too late to stop serious attrition of your wealth! These will merely show the effects of a decline in the business. Spotting this downturn earlier may save you even more money. This is easier said than done.

A decline in operating margin often suggests something is wrong. This means the companies' products have either been marked down to make them more desirable, or costs have risen without an additional boost to profits. To work out the margin divide operating profits by turnover.

Be careful if this figure is falling year-on-year. Seek an explanation from directors if it is. If you are not happy with the reason given it may well mean the business model is past its sell-by date or else things are getting more competitive in this sector. Those with poor balance sheets may suffer.

Airlines, such as British Airways, have struggled in recent years because they have extremely thin margins of less than five per cent. However, their fixed costs are immense and mostly funded by debt. Budget airlines such as Easyjet or Ryanair have squeezed margins even more, making the sector even more competitive and pushing those with weaker balance sheets to the wall.

Read between the lines

Naturally few managing directors will say business is poor and admit they are struggling. You will need to use detective skills to pick up the subtler indicators that the management is not completely focused on the business.

In the last interim report before Independent Insurance collapsed executive chairman Michael Bright confidently asserted that 'the business opportunity going forward is huge and we now have the right team to fully exploit this potential'. Famous last words.

A stream of overly optimistic 'newsflow' can also indicate problems ahead. Eli Reifman of Geo Interactive Media said he wanted to release a positive piece of information on his loss-making software company every week! Could this be to distract investors from the group's mounting losses?

Aim-listed Just, which licences children's TV characters, continues to trumpet its latest merchandising deals, despite recently releasing a profit warning out of the blue.

Hendry of Odey Asset Management warns that investors should retain some emotional detachment from a company's generally optimistic executives: 'You get little from meeting management', he alleges.

Deal with directors

Whilst you may not be able to believe every word a director says, their actions should be more significant. Most obviously money speaks with far more authority. If a director sells shares in his company despite sounding positive, things may not be so bright.

At the peak of the dotcom craze in March 2000, David Potter, chairman of electronic gadget maker Psion, placed nearly £100 million worth of shares at 1300p. Psion's shares, after several profit warnings, now stand 96 per cent lower at around 50p.

Similarly, the directors of Independent Energy sold shares at that point, making about £30 million nine months before the company called in the receivers.

Subtle signs

If the director of a company you have invested in seems to be lying back with his foot off the gear then you should also start to worry. Shortly after Nikki Becket of software developer NSB Retail was named Entrepreneur of the Year, the company encountered difficulties and the share price tumbled.

Other trappings of prosperity can prove distracting. Avoid directors with a penchant for smart offices, fast cars, sharp suits and flashy accessories! Many thought Marconi was setting itself up for a fall when Lord Simpson moved the company's headquarters from Lord Weinstock's no-frills offices to swanky new premises.

If a company changes the end of its accounting year, beware. This could be a ruse to cover up poor trading earlier in the year. Releasing figures at a quiet time of the year, such as between Christmas and New Year, is also a classic way of doing this.

A string of acquisitions, resulting in exceptional charges for a number of years, could also mean underlying trading is weaker than in the acquired entities. If these purchases are funded by debt, then there could be problems further along the line.

When a company's principal advisers resign you should also pick up a bad odour. Even worse is if the finance director departs. This may mean the boardroom is divided about strategy. Executive chairmen with majority stakes can be particularly hard to dislodge and could spell disaster.