When analysts and others conduct autopsies of companies that failed, they very often identify at least some of the following warning signs that occurred in the months before the companies filed for bankruptcy and shuttered their doors. Some of these warning signs may be considered subtle – and some not – but most, if not all, occurred outside the public's view. Here are 10 subtle warning signs that a company may be in big financial trouble.
1. Dividends Are Cut
When a publicly traded company cuts dividends, it doesn't necessarily mean that the company is bleeding, but companies that need to boost revenue will often cut dividends. If you read that a company is cutting its dividend, file it away as a sign that the company might be facing tough times. You can really worry if the dividend cut comes at a time when the company is losing profitability and has a shrinking pile of cash.
2. A Company Replaces Its CFO
This is usually one of the first things a troubled company does to try to turn things around. Its board recognizes that it needs someone better than it has during this time when a company's future is at stake.
3. A Company's Cash Reserves Are Shrinking
Companies go through their cash fast if they're losing money on a regular basis. If it is a publicly traded company, look at a few years of its balance sheet and look at its cash reserves. Are they growing or shrinking?
4. Internal Candidates Are Filling Key Positions
Companies in financial trouble are often more focused on cutting costs than on raising revenue. So if top executives are abandoning ship and companies need to fill those positions, they often look in-house and hire less-qualified managers for a lot less money than they would pay external candidates. The upside is that these managers know the company well and other employees often appreciate that the company is rewarding a current employee with a promotion. That appreciation breeds loyalty which a struggling company needs as well as money.
5. Salaries Are Frozen
Thousands of companies froze salaries during the nation's recent recession and those freezes continued as the recession was followed by economic sluggishness. But as many people know, no expense is larger than personnel. Therefore, if a company freezes salaries during a period when the economy is booming, that very well might be a warning sign that the company is in finanical trouble. Or it might mean that a company accustomed to high profit margins wants to keep those margins high and freezing salaries is how they choose to do it.
6. Auditors Are Replaced
Publicly traded companies have their books audited by an outside accounting firm and companies sometimes switch firms. But if a switch happens for no apparent reason that might mean a financial crisis is in the company's future. The company might not like how the accounting firm is classifying revenue or expenses and it wants to hire a firm that will do things the way it wants. A less subtle red flag is if the auditor's summary letter points out problems with how the company accounts for its revenue and expenses or if the letter questions whether the company can continue "as a going concern".
7. There Is An Especially Big Push For Revenue At The End Of The Fiscal Year
Any company wants its revenue to increase year after year and ideally the company wants to see month-after-month growth. If a company is forcing its sales staff to work 60- and 70-hour weeks to boost revenue during the months before a fiscal year ends, that could be a warning sign of desperation.
8. Executives Are Selling Shares
This is one of those signs that does not, in and of itself, point to trouble. Executives sell their shares from time to time, especially if they think the stock price is high. But if everyone seems to be selling a lot of their shares at the same time, it could mean a bankruptcy filing or tough times are ahead.
9. A Company Is Cutting Benefits
Personnel costs are any company's biggest expense, but salary is only part of the equation. Benefits often make up about a third of an employee's compensation and when companies change health-care, 401(k) and pension plans, it might be a sign of trouble. This is especially true when the cuts are severe and they are in conjunction with other warning signs.
10. A Company Has A Fire Sale
It begins selling its products, equipment and real estate to raise money.
Many of these warning signs are not evident to investors, especially to those investing in private companies. But if you invest in publicly traded companies, there is a lot of information available that gives you a glimpse of what's happening in boardrooms and executive suites. Seek out this information. It might help you to get out of a souring investment before it's too late.