Every entrepreneur’s nightmare is to see his business go bankrupt and fold up. It becomes even more horrifying if the company were forced to sell its assets to settle its financial obligations. Very often, the symptoms of a financial disaster are ignored until it’s too late. Here are eight telltale signs of a financial disaster and how to prevent them from happening:
1. Increasing debt-to-asset ratio.
Buying merchandise on credit and borrowing money for expansion are normal business transactions. But if the total payables — as a percentage of assets –increase over time, then it is a sign of over leveraging, a highly risky situation. A debt-to-asset ratio of more than 50 percent is considered potential trouble, and something must be done about it. A business is highly leveraged if more of the company’s revenues go to paying debts. It also means a bigger drain on cash flow and profitability.
2. Turtle-paced inventory turnover.
This is caused either by slow sales growth or an increasing inventory without a corresponding increase in sales. In any case, the business is not managing its cash prudently. Too much cash tied up to slow moving inventory indicates liquidity problems in the near future.
3. Unpredictable and erratic sales.
When sales become irregular, so do cash collections. And when cash inflows become highly volatile, the business may not be able to finance all its disbursements and payables. This may result in the company regularly taking out bank loans to fund its working capital needs to sustain the business.
4. Weakened pricing power and deteriorating gross margins.
These usually happen when the market becomes highly competitive, forcing the business into a price war. It’s usually not a good strategy to compete on price, aside from the fact that doing so would lower the business’s overall profitability.
5. Slowdown on cash collection.
A sluggish collection time lengthens the period a sale is converted into cash. This may force the business to turn to outside financing sources while it waits for its receivables to be collected. Again, this increases the risk of a cash flow problem.
6. Bouncing checks and delayed payments.
Receiving bounced checks and having overdue payments are indicators of the business’s imminent collapse, and poor monitoring and forecasting are the culprits. Cash usages must always be matched with cash sources.
7. Undercapitalized business equity.
Either the business is deep in debt or operating unprofitably. When it is caused by accumulated losses, the business has to borrow more to continue operating. This increases the risk of a huge financial loss, eventually wiping out its equity.
8. High employee turnover.
This may be interpreted as lack of faith in the company or its management. And without the right people to run the business, the company will suffer.
How to cure the symptoms:
- Evaluate your product or service for its competitiveness. Review your price points against margin levels that would sustain your business.
- Adapt your product or service to demand shifts as a result of technological advances and the entry of new competition.
- Monitor your cash flow regularly to know your true financial condition at any given time. Any decision on money matters will be easier if you know how much you have in the bank.
- Implement good accounting practices by recording all transactions properly for a subsequent review and assessment of the business’s financial performance.
- Improve your people management skills and recruitment practices.
- Practice financial planning for the business, for yourself, and your key employees to protect you from unexpected events such as illness, unfavorable business incidents, and the pullout of a major client.