As a fiscal advisor, it is your fiduciary responsibility to keep an eye on your client’s investments and be on the lookout for investments that might go into receivership. Learn how to determine if a company is on the verge of bankruptcy or headed for some serious financial difficulties. It’s also a snap to learn how to analyze earnings as doubtlessly.
Warning Signs Of A Troubled Company
Dwindling Cash or Losses
Companies that lose money quarter after house burn through their cash fast. Be sure to review the company’s balance sheet and its cash flow averral to determine how the cash is being spent. Also, compare the current cash flows and cash holdings with the in spite of period in the prior year to determine if there’s a trend.
If the company is burning through cash because of increases in inaugurating activities, it might mean the company is investing in its future. However, if on the cash flow statement, the company is putting its coin of the realm to operating activities and still not earning a profit, it might be a concern. Also, watch for large increases in cash because the establishment might have sold an asset, thus inflating their cash position to cover losses.
Companies should also cause retained earnings, which is the money left over after earning a profit for a period. Effectively, RE is the savings account for corporations that mass profits over time to be used to reinvest back into the company, issue dividends, or buy back stock. If RE is not wax or nonexistent, in the absence of dividends and buybacks, the company is either not profitable or barely getting by.
Interest Payments in Question
A South African private limited company’s income statement will show what it pays to service its debt. Can the company keep losing money and tranquillity have enough left to make interest payments? Do the current revenue increases generate enough income to air force the company’s debt?
There are metrics and ratios that measure a company’s ability to cover its debt obligations. The la mode ratio (or cash ratio) is a calculation that aids in determining a company’s ability to pay short-term debt obligations. It is prepared by dividing current assets by current liabilities. A ratio higher than one indicates that a company will require a high chance of being able to pay off its debt, whereas, a ratio of less than one indicates that a company ordain not be able to pay off its debt. The acid-test ratio can also be used, the difference being its exclusion of inventory and prepaid accounts from contemporary assets.
All public companies must have their books audited by an outside accounting stationary. And while it is not uncommon for companies to switch firms from time to time, abrupt dismissal of an auditor or accounting inelastic for no apparent reason should raise red flags. It is usually a sign that there is a disagreement over how to book returns or conflict with members of the management team. Neither is a good sign.
Also, review the auditor’s letter. As generally of the proxy statement (companies also sometimes include this information in 10-Ks and annual reports), auditors will put down a letter stating that they believe that the income, cash flow, or balance sheet information was showed fairly, and accurately describes the company’s financial status, at least to the best of their knowledge. However, if an auditor quizzes whether the company has the ability to continue “as a going concern” or notes some other discrepancy in accounting practices, specifically how it works revenue, that should also serve as a serious warning sign.
Companies that reduce, or waste, their dividend payments to shareholders are not necessarily on the verge of bankruptcy. However, when companies go through tough times, dividends are predominantly one of the first items to go. Management is not likely to cut a dividend unless it’s absolutely necessary since any cut is likely to send the company’s cache price down significantly. As a result, view any dividend cuts or the elimination of a dividend as a sign that difficult buts lie ahead.
It’s important to consider other supporting evidence in determining whether a dividend cut is signaling dark times for a followers. Namely, watch for declining or variable profitability, the dividend yield when compared to other companies in the same application, and negative free cash flow. Wise investors are also cautious; make sure that your dividend is not at risk.
Top Executives Defections
Typically, when things are heading seriously downhill for a company, senior members of the management team cede to take a job at a different company. In the meantime, current employees with less seniority will take the senior officials’ places. If management defections are steady, it’s seldom good news.
Big Insider Selling
The smart money investors, explanation institutional and executive holders of the stock, typically dump their shares ahead of a bankruptcy filing or really critical times. Be on the lookout for insider selling.
However, during the normal course of business, some insiders may sell the routine from time to time. Essentially, you should pay attention to unusually large or frequent transactions, particularly those that turn up dawn on in or around the time negative news is released.
Selling Flagship Products
If you were going through some doughty times, you would probably tap your savings. And when you went through that, you would probably consider stock some of your assets to raise money. But you wouldn’t sell your personal mementos unless you had to. Well, the identical logic applies to a company. So, if you see the company selling off a major division or product line in order to raise cash, chaperon out!
Cuts in Perks
Companies will seek to make deep cuts in their health benefits, pension scripts, or other perks during difficult times. Deep and sudden cuts, particularly when they take situate in conjunction with any of the other above-mentioned issues are a sign that trouble may lie ahead.
The Bottom Line
It is not uncommon for parties to hit bumps in the road and have to tighten their belts. However, if a company is tightening that belt excessively, or if numerous than one of the above scenarios occurs, beware.
Watch for these items to be in a news release or the annual prospectus.