Financial statements tell only part of the story. Investors, lenders and other stakeholders who know how to identify red flags of impending problems can protect their own financial interests. Additional due diligence may be needed to uncover these issues. For instance, stakeholders might need to talk to management, visit the company’s website and compute financial benchmarks using the company’s most recent financial statement. Here’s what to look for.
Employees who jump ship
Employee turnover — at all levels — often precedes weak financial results. One obvious reason is that company insiders are often the first to know when trouble is brewing. For example, if the plant manager’s innovative ideas are frequently denied due to lack of funds or if employees hear shareholders bickering over the company’s strategic direction, they may decide to seek greener pastures.
The reverse happens, too. If certain key people leave the company, it may cause revenue or productivity to nosedive. Given time and sufficient effort, most established companies can recover from the loss of a key person.
Another reason for high employee turnover may be layoffs. Companies that can’t meet payroll may need to shed costs and dole out pink slips.
Employee turnover can also be a vicious cycle. Top performers in an organization may respond to perceived financial problems by moving to healthier competitors. That leaves behind the weaker performers, who must train new hires on the company’s operations. Finding and training new workers can be time-consuming and costly, compounding the borrower’s financial distress.
Working capital concerns
Working capital is the difference between a company’s current assets and liabilities. Monitoring key turnover ratios can help gauge whether the company is managing its short-term assets and liabilities efficiently.
When accounts receivable turnover slows dramatically, it could signal weakened collection efforts, stale accounts or even fraud. For example, a company that’s desperate to boost revenue might solicit business with customers that have poor credit. Or one of a company’s major customers might be underperforming and it’s trickling down the supply chain.
Likewise, beware of deteriorating inventory turnover. Similar to receivables, a buildup of inventory on a borrower’s balance sheet could signal inefficient asset management. Certain product lines may be obsolete and require inventory write-offs. Or a new plant manager might overestimate the amount of buffer stock that’s needed in the warehouse. It might even forewarn of fraud or financial misstatement.
Changing market conditions
External factors may affect a company’s financial performance, but the effects vary from company to company. For instance, some companies permanently closed when the economy shut down during the COVID-19 pandemic, while others pivoted and prospered.
Today, business performance may be adversely impacted by geopolitical pressures, rising interest rates, supply chain shortages and inflation. Stakeholders should continue to monitor financial results closely in these volatile conditions.
When a company shows signs of financial distress, stakeholders should encourage management to supplement its year-end financial statements with interim reports or engage a CPA to perform targeted agreed-upon procedures. Doing so can help the company assess risk, identify problems and brainstorm corrective measures, if needed. Contact us for more information.
Information provided on this web site “Site” by Thompson Greenspon is intended for reference only. The information contained herein is designed solely to provide guidance to the user, and is not intended to be a substitute for the user seeking personalized professional advice based on specific factual situations. This Site may contain references to certain laws and regulations which may change over time and should be interpreted only in light of particular circumstances. As such, information on this Site does NOT constitute professional accounting, tax or legal advice and should not be interpreted as such.
Although Thompson Greenspon has made every reasonable effort to ensure that the information provided is accurate, Thompson Greenspon, and its shareholders, managers and staff, make no warranties, expressed or implied, on the information provided on this Site, or about any other website which you may access through this Site. The user accepts the information as is and assumes all responsibility for the use of such information. Thompson Greenspon also does not warrant that this Site, various services provided through this Site, and any information, software or other material downloaded from this Site, will be uninterrupted, error-free, omission-free or free of viruses or other harmful components.
Information contained on this Site is protected by copyright and may not be reproduced in any form without the expressed, written consent of Thompson Greenspon. All rights are reserved.
Ready to talk to one of our specialists?
Our specialists are all seasoned professionals who have years of experience working within your industry. Reach out to us today to schedule a consultation.