How do you know if a company is failing?

There are a combination of factors that cause company failure

How do you know if a company is failing?

You’ll find there are a combination of factors, here are our top ten warning signs to look for:

Warning Sign Why
1. The company has too much debt You want to look at the company’s gearing ratio (i.e. how much of the firms activities are funded by the owners in comparison to creditors). If this ratio is high and paired with a low interest cover ratio (meaning how easily a company can pay interest on outstanding debt) then this can indicate a company is under stress.
2. Over-expansion A debt-fuelled acquisition spree (borrowing to buy a number of companies in a short period of time) is risk, even when you have the expertise and know what you are doing.
3. You don’t know what the business does

If you don’t know what the business does or how it generates cash, steer clear of it.

4. Qualified Accounts or Going Concern commentary

Qualified accounts are audited accounts where the auditor has doubts or disagreements with the firm’s management, this is a huge signal of failure.

Going Concern commentary is one step away, make sure you investigate fully.

Going concern commentary or an emphasis of matter, whilst not a qualification, can be deemed a way that an auditor covers themselves from being sued by making the reader aware of an issue but still signing off the accounts on a “going concern” basis.

5. Profit warnings

A profit warning advises that the company’s earnings will not meet expectations. This is normally announced two or more weeks before the official public announcement of the company’s earnings. Important you pay very close attention if there is a profit warning. 

6. Profit vs cashflow

Be wary of a company generating large profits but little or no cashflow from operations. They could well be employing “window dressing” practices.

Window dressing can involve accelerating sales at year end on extended terms without getting the cash in or bringing forward sales to meet forecasts. It can also involve ‘murky’ valuations around returns on projects or particular assets. It can also relate to changes in depreciation policies or capitalisation of interest or expenses.

7. Deteriorating payment practices If payments from the company are slipping or becoming irregular in ‘lumps’, follow up urgently.
8. Unstable Boardroom If there are surprise resignations at the board level this can indicate trouble ahead for the company.
9. Trappings of success Be aware of companies with high end, brand new cars, computer systems and furnishings. Directors could be rewarding themselves and ‘clocked off’.
10. Late filing of Accounts This can indicate problems within the company or getting the accounts signed off by the auditor.
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