Businesses usually do not fail overnight. Instead, they fail to recognize and proactively react to warning signs. Poor profitability, declining revenue, loan covenant defaults, and vendor payment stretching are obvious warning signs.
While every company is different, there are 12 operational areas distressed businesses often miss, which can foretell a deteriorating financial condition. Financial executives would be well served to keep these in mind to help clients address underlying causes of problems. Proactive measures may improve chances for a successful turnaround.
The obvious warning signs
A sudden or sustained decline in revenue is often one of the first warning signs of financial distress. This can be due to various factors, including declining demand for the company's products or services, increased competition, loss of a large customer or straining economic conditions.
A decrease in profitability is another early warning sign of trouble ahead. This can be due to higher costs, lower prices or a retreating market. If the company's profitability is deteriorating, it's important to take steps to improve margins and control costs.
Additionally, an increase in debt levels can put a strain on a company's cash flow and make it challenging to meet debt obligations. This is especially true in a rising interest rate environment like we are in today. If the company is taking on more debt, it is crucial to evaluate whether additional borrowing is actually required and how it will improve the company's long-term position.
Finally, difficulty accessing capital can signify that creditors are losing confidence in the company's ability to repay its debts. If the company is having difficulty accessing capital, it's essential to take steps to improve creditworthiness and restore creditor confidence.
The dirty dozen signs of operational distress
However, it's not always apparent that a business is in distress. In addition to the obvious warning signals, companies often overlook these 12 operational red flags to identify underperformance. These leading indicators or "the dirty dozen" are especially important to consider as economic uncertainty looms:
- Inability to reinvest in the business or take advantage of growth opportunities;
- Underutilization or excess capacity;
- Unbalanced labor productivity (too much overtime or idle staff time);
- Guessing on quoting and pricing; poor costing and estimating systems;
- Poor delivery performance or a high backlog;
- Unbalanced inventory (too much of what isn't needed and not enough of what is);
- Increased reliance on expedited shipping or missed shipments;
- Lack of key process metrics;
- Excessive inventory;
- Rework volume, high scrap rates and a disorganized shop floor;
- Excessive employee turnover; and,
- Difficulty paying vendors on time; consistently low availability on credit lines.
Act quickly
Time and money are crucial factors during a crisis, and restructuring experts can help quickly identify problems, remove obstacles, stabilize the business, and restore confidence. The sooner these areas of concern are identified and addressed, the better the chances for a successful turnaround. Yet, businesses may be reluctant to reach out for help. Perhaps cash flow has already become an issue, or they are concerned about what hiring outside consultants might signal to their organization or the market. Whatever the cause for the delay, there are valid reasons for business leaders to seek counsel as soon as they start to realize a shift in operational performance, before the bank or their customers begin to pressure them to do so.
Seeking an independent third-party assessment while resources are still available will help ensure that there is enough runway to hire an experienced financial and operational advisor — one that can help better position the company in the market and identify immediate and long-term operational efficiencies and cost savings.
Business owners concerned about the signals that hiring outside experts might send to their employees should assume that when a company is struggling, everybody knows within the organization. Much like when a family is going through a difficult time, the children are quick to pick up on the clues. It's no different for a company. The production crew knows they used to run three shifts and now they are only running one. The best way to handle uncertainty is to get control of the messaging by communicating that you are managing the situation, seeking expert guidance, and proactively taking action to restore confidence.
Strategies for an evolving risk landscape
Organizations face challenges every day. Today's economic headwinds are making it more difficult for management teams to effectively manage operations. Higher interest rates are negatively impacting businesses' cash flow, their ability to invest in their business, and in turn grow.
Businesses that are proactively collecting and leveraging the operational data stemming from "the dirty dozen" to flag distress signals appropriately are best equipped to prepare for and react to these risks and optimize business performance.
