Do you know the signs of financial distress in a business?

financial distress in business

The financial figures do not tell the entire story. Knowing how to see warning signs of coming issues allows investors, lenders, and other stakeholders to safeguard their economic interests. More investigation may be required to find these flaws. For instance, stakeholders may need to speak with management, visit the firm’s website, and use the most recent financial statement to compute financial benchmarks. Here’s what to look for if you feel your business is in financial distress:

Employees who jump ship

Employee turnover at all levels frequently occurs before poor financial outcomes. One apparent explanation is that company insiders often know firsthand the potential problems. As a result, employees may look for better opportunities. For instance, if the plant manager’s creative ideas are repeatedly rejected owing to a lack of funding or if they overhear stockholders arguing over the company’s strategic direction.

The opposite also occurs. The loss of certain critical employees could result in a sharp decline in income or productivity. However, most well-established businesses can bounce back from losing a key individual given enough time and effort.

Layoffs may also be a factor in excessive staff turnover. Companies that can’t pay their employees may need to cut expenses and issue pink slips.

The cycle of employee turnover can be brutal. When apparent financial issues arise in a business, top performers may leave for healthier rivals. The lesser performers are left behind and are responsible for educating new workers on how the company runs. The borrower’s financial difficulty might be made worse by the time and expense involved in hiring and training additional employees.

Working capital concerns

The gap between a company’s current assets and liabilities is its working capital. You can monitor key turnover ratios to see how effectively the company handles its short-term assets and liabilities.

Accounts receivable turnover that substantially slows down could be a symptom of fraud, old accounts, or worse collection efforts. For instance, a business scrambling to increase sales can approach clients with bad credit. Or a company’s key customer may be underperforming, affecting the rest of the supply chain.

Also, watch out for declining inventory turnover. An increase in inventory on a borrower’s balance sheet may indicate ineffective asset management, similar to an increase in receivables. Inventory write-offs may be necessary for some product lines due to obsolescence. Or a brand-new plant manager can overestimate the quantity of buffer stock that the warehouse needs. It might even forewarn of fraud or financial misrepresentation.

Financial distress in the marketplace

The effects of external factors on a company’s financial success vary from one company to another. For instance, when the COVID-19 pandemic caused the economy to collapse, some businesses permanently closed while others changed course and flourished.

Today, geopolitical tensions, rising interest rates, supply chain constraints, and inflation may negatively influence business performance. Accordingly, stakeholders should closely monitor the financial outcomes in these uncertain times.

Stakeholders could push management to include interim reports in its year-end financial statements. Otherwise, hiring a CPA may be beneficial to carry out specific agreed-upon procedures when a business exhibits indicators of financial distress. By doing this, the business may evaluate risk, pinpoint issues, and, if necessary, devise corrective solutions. Contact our RRBB accountants and advisors for further details.

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