Indicators of corporate distress
A drop in customers, rise in customer complaints, high staff exits, inability to attract talent, rising debt levels, delays in payment of wages, and steady rise in the cost of capital are some signs of trouble for a business better known as corporate distress. When these persist, you know that the company is struggling. Cash flow starts becoming an issue with such companies. These problems are often not visible on the balance sheet and may continue to appear healthy. However, if you begin analyzing the numbers closely, you will be able to detect signs of corporate distress early on.
A Founder once approached me to help turn around his venture. It was an IT services company that was largely into staff augmentation. The company was regularly reporting profits, its revenues were growing yearly, and the staff strength was rising, but its founder knew they were getting into trouble. He was facing challenges on the receivables front. He faced cash flow challenges and was forced to take on short-term working capital with higher interest rates.
When I looked at the project-level data, I noticed that the unit-level margins were below the debt servicing level leading to cash flow problems. From the outside, the company everything seemed to be looking good.
Corporate distress reasons will vary from company to company. Sometimes I have observed that the problem begins with management or senior staff disagreements. If they persist, the high-level exits of Founders and senior management indicate trouble. Investors should watch such signs, investigate and take appropriate action.
In other cases, companies grow rapidly, and their supporting processes and structures cannot handle the growth. It leads to product quality deterioration, customer complaints, and a diminution of the customer base. We find this problem common in startups that are growing rapidly. Such entities cannot quickly restructure and build processes appropriate to efficient organizational management. A lack of processes, checks, and balances is essential to a corporation’s functioning. Companies facing such issues either wither away or are acquired by competitors.
Companies facing corporate distress are candidates for sale. But will these find a buyer is a different question? That will depend on market conditions, demand for its goods and services, brand perception, customers, social and political conditions in the market in which they operate, and prospects of future growth.