While not necessarily terminal, ongoing financial difficulties can have a serious impact on a company’s operations, profitability, and even share price, which is why it’s important for shareholders to stay informed about the financial health of any company you investe in. Being aware of the signs that a company is in financial trouble can help shareholders make informed decisions and take appropriate actions to protect their investments.
Below, we will discuss 8 key signs that shareholders should watch out for when it comes to identifying whether or not a company is in financial trouble.
Declining Revenue and Profits: One of the most significant indicators of a company’s financial health is its revenue and profitability. If a company’s revenue is consistently declining over a period of time and profits are shrinking or turning into losses, it may indicate underlying financial issues. This could be due to various factors such as decreasing demand, pricing pressures, increased competition, or operational inefficiencies. Shareholders should monitor the company’s financial performance regularly, review financial statements, and compare them to industry benchmarks to identify any downward trends.
Increasing Debt & Interest Payments: Rising debt levels and interest payments can be red flags for shareholders. Taking on excessive debt to finance operations or expansion can lead to increased interest expenses and debt servicing costs, which can erode profits and strain cash flow. Shareholders should review the company’s debt levels and interest payments, and assess whether they are increasing disproportionately compared to the company’s revenue and profitability as high levels of debt and interest payments can be an indication of potential financial distress.
Cash Flow Problems: Cash flow is a critical aspect of a company’s financial health. If a company is struggling to manage its cash flow effectively, it may indicate financial troubles. Poor cash flow can manifest in different ways, such as delayed payments from customers, increased accounts receivable, difficulties in paying bills and suppliers on time or relying on short-term borrowing to cover operational expenses. Shareholders should review the company’s cash flow statements and assess whether there are any persistent cash flow issues that may impact the company’s ability to meet its financial obligations. It could be that the business is in trouble or someone in the finance department is trying to be clever but whatever the reason, it’s bad for a business’ reputation.
Inability to Meet Financial Obligations: A company’s ability to meet its financial obligations, such as paying employees, suppliers, taxes, loan installments, and so on is crucial for its financial well-being. While it’s not unusual for the odd invoice to slip through the gaps and go unpaid past due, consistently struggling to meet financial obligations or regularly defaulting payments are strong indications that a company is in financial distress. Shareholders should review the company’s financial statements, assess its liquidity position, and monitor any instances of missed payments or defaults.
Deteriorating Asset Quality: The quality of a company’s assets can also provide insights into its financial health. If a company’s assets, such as inventory, receivables, or properties, are deteriorating in value or becoming obsolete, it may indicate financial troubles. Shareholders should review the company’s balance sheet, assess the quality of its assets, and monitor for any significant write-downs or impairments that may signal financial distress.
Negative Operating Cash Flow: Operating cash flow refers to the cash generated or used by a company’s core operations. If a company consistently generates negative operating cash flow, it may indicate that its core operations are not generating sufficient cash to cover its expenses, which can be a sign of financial distress. Shareholders should review the company’s cash flow statements and assess the trend in operating cash flow over time.
Management Changes or Red Flags: Changes in the company’s management team, such as frequent turnover of key executives, or sudden departure of senior management without clear reasons, can be red flags for shareholders. Additionally, any indications of unethical practices, such as accounting irregularities, fraud, or non-compliance with financial reporting standards, should be closely monitored. Such red flags may signal underlying financial troubles.
Impending Regulatory Changes: External factors such as regulatory changes can also significantly impact a company’s finances. Depending on what new regulations entail, they can do so by increasing compliance costs, imposing penalties and fines, necessitating changes in business practices, affecting market access and competitive advantage, and impacting reputation and brand value. Companies ought to closely monitor and adapt to regulatory changes in order to effectively manage the financial impact and mitigate potential risks. As a shareholder, you should expect any company you’re invested in ought to have thoughtfully planned out how they intend to navigate any upcoming new regulation.
Any one of these 8 signs may indicate that a company is facing financial challenges that could potentially impact its ability to generate profits and provide returns to shareholders. As a shareholder, it’s crucial to be vigilant and proactive in monitoring the financial health of a company you’re invested in, and recognising the signs that a company is in financial trouble will help you make informed decisions and protect your investments. If you begin to identify signs of financial distress, consider seeking professional advice and taking appropriate actions, such as divesting, requesting an independent business review be carried out, or engaging with the company’s management to address the issues.
