02 October 2007

Warning Signs Of A Company In Trouble

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 that something is amiss is a frustrated stakeholder – be it the owner, investors, or lenders. 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?

Where to Start

It is best to first take a look at the company’s financials. Start with the balance sheet. 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 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. 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 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 in a troubled company, but rather misdiagnosing the company’s problem(s).


Here are some items to consider when performing diligence on a company:

Cash shortfall – does the company seem to be constantly in a cash crunch?

Physical deterioration of facilities – signs of inability to maintain facilities due to lack of proper planning and ability to re-invest.

High concentration of leased assets – inability to secure traditional financing.

Lender blamed for current condition – 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.

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 preferring 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 – the creation of financial statements which do not accurately reflect the company’s true performance and 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 – a management team counting on the next product line, next store, or next IT system implementation to solve its troubles is likely to not be focused on tackling the true problems facing the company.

Inventory is over weighted in slow moving items – this can indicate a lack of unwillingness to write-down assets and accept reality.

Quality issues with products and services – an indicator of poor management and future loss of sales.

Market share losses – this can indicate an inability of management to compete in the marketplace and presages future financial pressures.

Backlog declining – the company faces the potential of declining future sales and EBITDA.

Departure of key employees – May indicate an inability to pay talent their market rate or otherwise maintain an attractive work environment. Also may indicate that key employees realize the company is in trouble.

Unmotivated/depressed employees – the general 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.


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 would like to discuss this topic in more detail please feel free to contact us.


Michael Fingland
Managing Director

M +61 407 226 968
T +61 7 3229 5750
F +61 7 3229 5765
Level 5, 247 Adelaide StreetBrisbane QLD 4000



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