Magazine article Business Credit

Early Warning Signs of a Bankruptcy

Magazine article Business Credit

Early Warning Signs of a Bankruptcy

Article excerpt

After every bad debt or loss due to a bankruptcy, businesses ask themselves if they could have prevented the loss. Could they have predicted the bankruptcy? Were there signs that they missed? There are a number of early warning signs, which indicate that a company is experiencing problems. Being aware of these signals can help companies prevent losses due to a bankruptcy. Warning signs can be categorized into Operational, Managerial and Financial signals.

OPERATIONAL SIGNALS include internal problems such as a change in senior management, high employee turnover and Board of Directors resignations; one-time events, such as a large bad debt or warranty claim, a strike or uninsured fire or theft; market changes; product obsolescence; a change in suppliers or payments to suppliers; pricing issues and a decline in performance, such as quality control problems.

MANAGERIAL SIGNALS encompass an inadequate management system, mediocre management skills and certain personality traits and habits. For example, a management system that lacks depth and relies on one individual for decision making, creativity and marketing prowess may be indicative of a company that may be under duress. An inexperienced management team with weak financial and organizational skills may foreshadow problems. Finally, habits and personality traits, such as not returning phone calls, working after hours, personal problems and frivolous spending, may hint at pending or future problems.

FINANCIAL SIGNALS include a decline in sales, lower profit margins, sustained losses, increased debt, a highly leveraged balance sheet and reduced cash flow. Working capital may also decline and become negative as accounts payable grow at a faster rate than inventory and accounts receivable.

A company's relationship with its bank and any changes in that relationship is also a useful financial signal. Reducing availability on a company's operating line or a change in borrowing patterns, although there has been no change in the business, may be indicative of financial problems. As well, an increase in loan security or a bank's request for security on a previously unsecured loan is clear evidence of a decline in the financial health of a business. …

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