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.
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).
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.
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.
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.
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.
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.
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.
Management is not focused on how the company generates earnings, instead they prefer to ignore it and replacing it with less valuable indicators.
A management team that is always putting out fires is less likely to be able to proactively plan to grow the company’s business.
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.
This indicates a willingness to push the envelope in the face of mounting negative business pressures.
This can indicate a lack of time for necessary oversight over management.
Management is unable to accept reality and deal with it accordingly, instead preferring to “shoot the messenger”.
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 that is overweighted in slow moving items can indicate a lack of unwillingness to write-down assets and accept reality.
Quality issues is a important indicator of poor management and future loss of sales.
When you lose market share, it often indicates an inability of management to compete in the marketplace and presages future financial pressures.
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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