Identifying Early Warning Signs of Corporate Distress

Since COVID-19, companies worldwide have been faced with increasing corporate distress. Formerly healthy businesses are now grappling with possible ways to initiate a corporate turnaround for their affairs, emphasizing the need for hiring business turnaround consultants to help them navigate these stressful times.

Read on to learn how to spot the early warning signs of corporate distress to help you save your business before things get too bad.

What Are Four Signs That a Business Might Be in Financial Distress?

There are many warning signs to show that a business is in distress or heading there. Like any regular illness, the key to surviving is to catch the symptoms early and manage them properly to prevent things from worsening (in this case, entering bankruptcy). The following events may indicate that your business is likely headed for financial distress.

1. Cash Shortage

“Cash is king” is a common phrase in the business world, and it is more than a cliche. Constant cash shortages are often the first undeniable sign that things are headed in the wrong direction with any business. Something is wrong when there’s never cash at hand.

We understand that periodic dips in cash flow are common, but when shortages become too frequent, it’s a red flag. A negative cash flow often indicates that your business is spending more money than it’s making on its operations—and no business can survive by running on negatives for too long (especially when interest rates are so high).

Excessive overhead costs are one of the many culprits responsible for draining a company’s cash flow. Others are bad spending decisions, customers being consistently late on their payments, etc.

2. Defaulting on Payments

Most people default on payments once in a while. However, the frequency with which these defaults occur may indicate that financial issues are coming, especially if you run a business.

A business that cannot pay its bills is likely underfunded, has poor tax practices, and is most likely heading toward bankruptcy. In this situation, you may want to look into ways to improve your cash flow, like collecting outstanding debts, selling off old stock, and forecasting your cash flow, to see the extent of your debt situation.

3. High Interest Rates

You must know that your lender is always on the lookout, assessing the creditworthiness of your business. Whenever your business becomes overwhelmed with loads of debts to service, it can raise red flags with these lenders.

This is a potential indication that your business’s financial health is now strained, and most lenders will flag your business as high-risk. The result is typically high interest rates whenever you try to borrow money again. These days, interest rates are already higher than usual to combat inflation, so it’s crucial to keep your personal rates low.

High interest rates can signal to the public that lenders are suspicious about your business’s viability and unwilling to risk their money on it without assurance. So, you're likely in corporate distress when your relationship with a bank or other lenders becomes strained, with them asking for additional security, declining loans, or even requiring personal guarantees.

4. Poor Profits and Falling Margins

Falling margins indicate one of two things: a drop in income or increasing costs. Both of these situations can put pressure on your cash flow. Experienced businesspeople know that profits count more than sales for a business to survive the long haul.

So, if your business is not doing well and is pulling low profits, you may be headed for corporate distress. In these situations, when a business struggles to make a profit and there is no clear business turnaround in sight, the owner(s) may have to rely on internal funds for sustenance.

However, proper businesses can only run on internal funds for so long. In these cases, such a business may then be forced to seek external funds, which can expose the operation to further risk.

Strategic Tips for Corporate Turnaround in Times of Crisis

Businesses can face financial difficulties at any time and due to many reasons, like bad decisions, sudden market changes, etc. But to achieve corporate turnaround, it is important to be strategic every step of the way. Below, we analyze some ways you can achieve a business turnaround for any distressed business.

1. Implement Crisis Stabilization Strategies

Crisis stabilization is often the lifeline for many struggling businesses facing corporate distress. This strategy has three main goals:

• To preserve cash resources through a review of current financial documents

• To rebuild stakeholders' confidence by showing that management is on top of the situation

• To guarantee that operations continue as they were before the crisis

Now, let’s take these goals one after the other. Conducting a financial document review is the first thing necessary for transforming your failing operation into a turnaround business. This will likely require you to go back at least three years to gather and review important financial documents.

These financial documents typically include balance sheets, profit and loss statements, cash flow forecasts, business plans, etc. This review will help you to understand the extent of the financial crisis that you are facing.

After this in-depth financial review, shift your focus to your cash flow; it’s time to save. You can sell off some assets, put financial control measures in place, improve your debt collection mechanisms, and liquidate surplus stocks.

Basically, anything to guarantee that there’s enough cash at hand. Then, you must prioritize managing the emotional response of your employees and other stakeholders. Here, apply transparent communication, acknowledge their concerns, and work toward rebuilding confidence.

2. Change of Leadership

The CEO of any business is at the helm of affairs and is typically the first port of call when there is corporate distress. Apart from external market forces, poor management from the top can be a factor that causes a company to tilt towards collapse.

As such, business turnaround most times requires a change of leadership. For instance, when you see in the news that a company is in distress, who is usually the first to get out of the door? The first to resign? You guessed right: the CEO.

But does the board consider the CEO’s removal as important? The CEO is often in charge of the day-to-day operations and is the link between the directors and top management.

So, apart from having a new leader to pilot the company’s affairs, the move is a strategy to inform stakeholders and the media that the company is reorganizing the house to fix things.

Essentially, it increases trust in the firm and may save stocks from plummeting further. At times, this can also mean the exit of some other senior management members depending on their roles in the company's distress.

Once people attached to the problem are identified, you can inject fresh energy by hiring new people to drive the corporate turnaround.

3. Rallying for Stakeholder Support

As the dust settles, after identifying the root cause of the financial crisis, the next logical thing to do is to get stakeholders on your side. This is because their jumping ship will cause your business to sink more than before.

But who are these stakeholders? They can be anyone from your financiers to creditors, employees, government entities, boards of directors, and even the press. A common mistake people often make is prioritizing financiers in a season of corporate distress.

However, it is important to carry all stakeholders along to the extent of their level of interest in your business and general influence or power. Sometimes, people focus only on customers, trying to rebuild their trust. But what happens to your suppliers and those who pump cash into your business?

Once you have identified the relevant stakeholders of your business, the next goal is to convince them that a business turnaround is a better alternative to cutting ties. This is where efficient communication comes into play, and hiring a business turnaround consultant is relevant.

You can leverage phone calls, virtual meetings, emails, newsletters, online platforms, and other communication channels to reach out to these stakeholders. Whatever communication method you adopt must be personalized to that stakeholder; it should not be a generalized bulk SMS or mass email.

In your communication, address their specific concerns and share tips on how you plan to address these challenges. Also, hear them out when they give feedback, and keep assuring them throughout.

Move Your Business Forward

Recognizing early signs of corporate distress is more than a choice; it’s a necessity for any business interested in growth. Any delayed action in the face of financial challenges may lead to the unprecedented closure of your business. 

At Foreword Companies, we have a track record of helping various businesses across different industries to circumvent business turnaround challenges. If you're facing corporate distress, you can count on us to give you all the support and guidance you need to scale through. Schedule a call with us today to get started.