Is it possible to know when a company is drowning in a deep financial distress? The answer is yes.
When insolvency comes knocking (literally), investors and business partners go back in time to see if there’s anything they should have probably done better. At such a time, the business is in deep financial distress, but the public may not know it yet.
In this article, you’ll learn of the different signs to help you know when a company is in financial distress.
What Causes Financial Distress?
Mismanagement of funds, diversion of resources (including funds and assets) and bad investment decisions are the top reasons why a company or business declares bankruptcy.
Higher production costs, a steady decline in profits and premature expansion are some reasons why some businesses suffer financial setbacks.
Signs of a Financially Distressed Company
When you notice the following happening, it’s time you begin to take action before the company becomes insolvent.
1. Managerial Defections
You know for sure that a company is about to go bankrupt when the top business executives jump ship. When the senior members of the management team begin to leave or join other companies; it’s proven that all is not well.
2. Delayed Payments to Creditors
Most businesses are indebted to creditors and offset their bills as soon as the funds are available. While being indebted to creditors is not entirely bad; it leaves a sour taste in the mouth when the following begins to happen:
- Delayed or extended payment days for the creditors.
- Being chased down, called out or dragged to the law court by the creditors.
- Extended creditor days also mean that the company’s credit score might be negatively impacted and securing future loans is nearly impossible.
3. Insider Selling
Companies with stocks often experience shares-dump, whereby most of the shareholders begin to sell their bags.
Executive holders and institutional investors who are privy to the company’s financial issues would likely sell off most of their stocks just so they don’t lose much if the business goes bankrupt.
4. Pay Attention to the Company’s Books
During the quarterly or annual reports; the public can be let into the financial standings of a company. Take what the books say seriously.
Here are some telltale signs of a financially distressed company, judging by the books:
- Auditor Replacement: a company’s auditor can be replaced for various reasons, ranging from strained working relationships and disagreements on the financial records. Keep an eye open if the company constantly changes its auditors.
- Discrepancies in the company’s financial records.
5. Cash Flow Issues
You know that the business is on the way to declaring bankruptcy if it has a consistent streak of negative cash flow. Going by the age-old saying that “cash is king;” a company that doesn’t generate enough cash might just be on the way out of business.
While periodic cash dips are common, it calls for concern when the following happens consistently:
- Limited revenue generation because customers aren’t paying up (or on time).
- Loan refinancing and;
- When the company keeps borrowing to finance the operations and investment purposes.
6. Notice the Desperate Grab for Cash
A business is gasping for cash when it becomes desperate to generate money by deploying different strategies. While some opt to reduce the prices of goods or services; others opt to sell off some of the treasured business assets to raise money.
7. Defaulting on Bills
Aside from paying off the creditors; a company also needs to pay up its bills. When these bills begin to pile up and nobody is picking the tabs; it could be because the instrument (cash) needed to make it all go away is not available.
8. Cutting Costs at all “Costs”
You should be worried about a company’s financial standing if it continually tries to cut costs by way of:
- Reducing the quality of services or products offered.
- Not meeting up with order fulfillment.
- Zero or late response from the customer desk, indicating either that the staff responsible is no longer working there or the company doesn’t have the right answers to customers’ queries.
9. Changes in the Market Environment
While companies are poised to remain in business because of the quality of products/services offered; others may be unable to stay for long when a strong competitor appears.
A dramatic change in the market environment by way of changes in what the customer base wants could put a hole in a company’s finances.
10. Tampered Financial Statements
A company becomes fudgy with its accounts and makes efforts to tamper with the financial statements when it has something to hide. From inflating the units of products sold to misrepresenting the amount in the bank; these are warning signals that the business is in financial distress.
11. A Financially-Distressed Company is in Debt
Debts are “normal” but not paying back on time or utilizing the money for something useful is where the problem is.
A warning sign that a company is in financial distress is when its debts are not adding up.
- How much (in debt) has the company taken in recent times?
- What type of debt does the company have? Long-term debts are not always a good sign.
- Check if the long-term debts are used to finance short-term liabilities. It’s a warning sign of financial stress.
12. Distressed Companies Remove Certain Privileges
If a company has been offering perks like pension plans, insurance covers and health benefits; those might be reduced when it becomes financially distressed.
By cutting down on these perks, the company hopes to save some money to start rebuilding its finances.
So, pay attention when some employees start talking about not getting these perks in the last couple of months.
Conclusion
Financial-induced friction is common in the business world, but if not well-handled, can metamorphose into a long-term streak often resulting in bankruptcy.
The signs mentioned in this article are prevalent among businesses that are on the path to insolvency. As an investor, you want to watch out for those and make important decisions as to how to salvage your commitment to the company.
As always, having a reliable financial expert helps such a company to find better ways to fix its financial distress.
