Recognizing & Responding to Signs of Trouble
Added on December 4, 2013
In this extended poor economic environment, many companies are dealing with the difficulties associated therewith. Management’s response to this overall economic malaise has ranged from inaction to over action and everything in between.
In the face of the range of management responses, how do you spot early signs of trouble?
There are three very broad categories that you should consider when assessing a situation: General Business Signs, Financial Statements, and Management.
Generally, evaluating these three broad categories can help you identify early warning signs or further your understanding of known problems. Importantly, these are not the only three categories of concern, but good starting points.
General Business Signs:
When conducting your normal business review of your borrowers or when evaluating a new loan, consider whether the business appears well run and in control. Some of the things to consider when making this assessment are as follows:
- What is the appearance of the facility and operations?
- Is management constantly firefighting problems or operating under the “Whack-a-Mole” strategy?
- Is the business facing external pressure from mounting creditor or customer issues? Is the business embroiled in lawsuits?
- Does the business suffer an inordinate amount of turnover? Did they lose any key management personnel unexpectedly?
- Is there a widening credibility gap between management and lenders or investors?
- Are financial statements and reports completed in a timely fashion?
What are the most recent financial results of the business telling you? Ask management about or look for the following in the company’s financial results:
- Is revenue declining? What is customer revenue mix? Is overall revenue flat, but customer concentration risk has grown? Is the company losing market share? Was there a loss of any major customers? How does backlog compare to a similar period in the company’s recent history?
- Is there gross margin or contribution margin erosion? If so, why?
- Is there any concern with the quality of earnings and EBITDA?
- How much cash is available for debt service or investment in the business?
- Is there a decrease in the ability to collect on accounts receivable?
- Is inventory growing without a corresponding growth in revenue or inventory turns? Is the mix of inventory between active and slow moving worsening? Is inventory properly valued? When was the last time a complete physical inventory was performed and reconciled?
- Is the borrowing base declining or is there a decrease in borrowing base availability?
- Is management preparing, but not releasing checks?
- Have all taxes been paid timely?
Key for lenders is how management chooses to operate when presented with, or is questioned about, subtle or tell tale signs of trouble.
- Is management defensive or in denial?
- Has management been operating under and relying on the “Grand Slam Plan”?
- Does management blame the lender for the woes of the business?
- Is management engaged in the business, disinterested or distracted by outside concerns?
- Are you concerned that management is dishonest?
Trouble exists or may exist, now what?
Once you suspect or have determined that trouble may exist at one of the lender’s borrowers, the sooner the root of the issues are identified and a plan is implemented the better for all constituencies. Consider engaging a professional firm with the expertise to not only effectively and efficiently assess the situation, but also develop and implement a plan before the value of the business continues to erode.
Where there is smoke, there is often fire. Act swiftly, quell the issues and you will have put the lender in a better position to prevent a fire from burning or spreading.
The professionals at Navera Group have been advising lenders, private equity investors and company management for over twenty years. We are experienced at not only identifying, but also devising and implementing tactical and strategic objectives in the face of adversity and transition.
With professionals based in Boston and Chicago, Navera Group provides early stage and middle market services domestically and internationally. For more information, please contact us.