Early Warning Signs of Financial Distress

By Brady Whitesel on March 1, 2023
Financial Distress

A company experiencing any of these warning signs might be in financial distress and its long-term value could be severely impacted.

  • Cashflow Distress: A business with cash flow trouble will present the following symptoms: 
    • Difficulty paying vendor bills on time, or meeting payroll cash requirements
    • Low operating cash reserves
    • Current Ratio less than 1.2 and trending toward 1.0.  When the Current Ratio is close to 1.0 it indicates that every dollar of cash inflow is met with a corresponding dollar of cash outflow, and it becomes very difficult to manage cash and build cash reserves.
    • Quick Ratio less than 1.0. When the Quick Ratio is less than 1.0 the company has insufficient cash and accounts receivables to cover its current liabilities.
    • A multi-month trend of declining cash balances
  • Learn six strategies to address cash flow problems.
  • Debt Distress: A business that takes on debt to cover its operating expenses is an indication of financial distress. A high debt-to-equity ratio is an easy way to determine if the company has too much debt.  If the debt-to-equity ratio is 2.0 or higher, or if the debt-to-equity ratio is trending toward 2.0, it will become increasingly difficult to secure additional financing or negotiate favorable terms with banks and creditors.
  • Revenue Distress: A trend of month-over-month decline in revenue is a sign of financial distress. This can be caused by a variety of factors, such as increased competition, changes in consumer behavior, or a decrease in demand for a company’s products or services.
  • Declining Gross Margins or Net Profit Margins: A decline in gross margin implies that the cost to deliver a product or service is increasing, or revenues are being held down by market forces.  Decreasing net profit margins are caused by rising costs, pricing pressure, or increased competition.  All of which are symptoms of financial distress.
  • High Employee Turnover: High employee turnover may be a sign of financial distress, especially if the business is unable to offer competitive salaries or benefits. High turnover likely impacts the company’s ability to deliver its product or service at a high-level, meaning that the company may be at risk of losing its customers to its competition.

These are just a few of the signs that a business may be in financial distress. If you are a business owner, it is important to monitor these indicators of distress and act quickly if any of them arise.  Work with your finance team to re-work your business and financial strategies to mitigate the warning signs.  If you don’t have a finance team, you should consider engaging with a fractional CFO firm who can help you navigate and overcome the symptoms of financial distress.

About the Author

Brady Whitesel is a Fractional CFO and is the Managing Partner of SignalCFO. SignalCFO was founded in 2016 and is a leading Fractional CFO firm located in Indianapolis, Indiana. They work with companies across the United States with expertise in SaaS (software as a service), manufacturing, professional services, data science and food service.