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Signs of a Company in Trouble
Usually, a troubled company has warning signs which are consistent across industries. When considering an acquisition of, investment in, or employment with a company it is best for your peace of mind, as well as, financially to be aware of indications that the company’s true picture may not be what management would lead you to believe.
The surest sign of a company in trouble is a frustrated stakeholder – whether it be the owner, investors, or lenders. Ask some of the following questions to your stakeholders:
- What are their concerns?
- Have there been repetitive problems with the company?
- Does management not seem to have the right skill set to handle the most pressing issues?
- Does management spend too much time assessing blame and not a lot of time accurately identifying the company’s problems and devising solutions?
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Where to Start
When asking where to start finding signs of a company in trouble, it is best to first take a look at the company’s financials. Start with the balance sheet of the company in trouble. Are they building inventory and not able to sell it? Do they have a negative cash position? Have they maxed out their borrowing base? Also, be sure that the balance sheet reflects the true state of affairs. For example, has the distressed company written a check which it has yet to mail despite debiting its accounts payable account?
Take a look at the income statement, preferably one with monthly performance over the last 12 months. Then, group the items into three categories: sales, variable costs including direct sales costs, and fixed costs. What trends do you see in those categories? Perform a breakeven analysis. What is their contribution margin? Is it declining? What about EBIT? Is the company able to service its debt?
It can be helpful to simplify a troubled company’s financial statements, combining similar items in order to move out of the detail and focus on the company’s overall performance and financial position. The greatest mistake is not necessarily investing organizations showing signs of a distressed company, but rather misdiagnosing their problem(s).
Signs of a Company in Trouble Checklist
Here are some items to consider when performing diligence on a company and search for those signs of a company in trouble:
Does the company seem to be constantly in a cash crunch? If so, this is a clear sign that your company is in trouble. Cash flow is the #1 reason why most businesses fail.
Physical Deterioration of Facilities
There are signs of an inability to maintain facilities due to lack of proper planning and ability to re-invest. Look around your facilities for indicators of this.
Poor Accounting Systems
Accounting records and reporting are delinquent. Often, the company does not know if they are making money or losing money. This lack of financial leadership will result in surprises and undesired results.
High Concentration of Leased Assets
If there is an inability to secure traditional financing, there is a reason for that. Your company is too risky for the bank or lenders to invest in you.
Lender Blamed for Current Condition
When your lender gets blamed for your current condition, it indicates a lack of willingness on management’s part to accept responsibility and look for solutions.
Mounting External Pressure
Litigation, displeased vendors and creditors, and troublesome audits… If you feel like the walls are caving in from external pressure, take a look at why they are doing that.
Poor External/Internal Communication
The lack of effective communication with external parties such as lenders and vendors, as well as, internally with employees can indicate the presence of negative information suppressed by management.
Critical Information Ignored or Discontinued
Management is not focused on how the company generates earnings, instead they prefer to ignore it and replacing it with less valuable indicators.
Defensive Management Team
A management team that is always putting out fires is less likely to be able to proactively plan to grow the company’s business.
Liabilities Ignored or Underreported
Often in troubled companies, the creation of financial statements do not accurately reflect the company’s true performance. As a result, their financial position can lead to much more aggressive actions than would be warranted, thus exacerbating a company’s problems.
Credibility Problems with Key Constituents
The inability for management to be trusted can create unnecessary hurdles for management.
Dishonest/Unethical Business Practices
This indicates a willingness to push the envelope in the face of mounting negative business pressures.
Ownership Distracted By Outside Activities
This can indicate a lack of time for necessary oversight over management.
Deny Accuracy of Negative Information
Management is unable to accept reality and deal with it accordingly, instead preferring to “shoot the messenger”.
Looking for a “Home Run” to Fix Everything
If a management team counting on the next product line, next store, or next IT system implementation to solve its troubles, then there are likely to not be focused on tackling the true problems facing the company.
Inventory is Over Weighted in Slow Moving Items
Inventory that is overweighted in slow moving items can indicate a lack of unwillingness to write-down assets and accept reality.
Quality Issues With Products and Services
Quality issues is a important indicator of poor management and future loss of sales.
Market Share Losses
When you lose market share, it often indicates an inability of management to compete in the marketplace and presages future financial pressures.
The company faces the potential of declining future sales and EBITDA.
Departure of Key Employees
Departure of key employees may indicate an inability to pay talent their market rate or otherwise maintain an attractive work environment. It may also indicate that key employees realize the company is in trouble.
Generally, the overall attitude of lower level management and employees on the shop is a good gauge of how things are going at the company. Oftentimes, they are able to catch on to a company’s troubles before it reaches the executive suite.
In conclusion, it is important to note that a troubled company often exhibits some combination of the factors described above. When examining a company, be sure to be on the look out for these potential warning signs. As always, seek first to have an accurate and meaningful set of financial statements to guide you. If you want to get your company out of trouble, then check out our free Internal Analysis whitepaper to guide you through what you need to either address or enhance.
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