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The business world has been turned upside down with COVID-19 and the financial disruption it has created. Once healthy businesses are taking protective measures to remain viable. The impact of this health and financial crisis has affected nearly all industries in some manner. Being aware of areas or issues where your company is vulnerable is critically important. We have identified ten signs to look for when evaluating whether your company has some degree of financial distress.   

What Is Financial Distress?

Financial distress is a condition in which a company or individual cannot generate sufficient revenue or income because it is unable to meet or cannot pay its financial obligations. This is generally due to high fixed costs, illiquid assets, or revenues sensitive to economic downturns. It can also be a result of external factors such as government restrictions on business operations in response to COVID-19.

Sign #1: Cash Flow Problems

The first sign things are going wrong is a constant lack of cash. All businesses suffer periodic dips where cash is tight. However, if cash flow is continually a problem, the business is likely in trouble. If a business is continually spending more than it earns, unless it is deliberate and well-funded (as with some start-up businesses) it will lead to problems. If money is coming in, but there is never enough to pay the bills, this is an indication that you need to look at the cash flow for your company.

These are some of the most common reasons your company’s cash resources being drained:

• Excessive overhead costs
• Heavy debt loads and high-interest payments
• Poor spending decisions
• Outstanding accounts receivable

Sign #2: Defaulting on bills

Everyone misses a payment or forgets a bill, but if the frequency with which it occurs increases, it suggests a business can’t pay its way. This is a sign it is underfunded, is having difficulty collecting its accounts receivables, or is heading to liquidation. While defaults to vendors may disrupt supply and erode business relationships, defaults on secured loans can be particularly damaging to credit.

Sign #3: Extended Terms

Being slow to pay is not as bad as not paying, but it can be an indication your business is in financial distress. A sign of possible trouble is a rise in either debtor or creditor days. If your business needs to delay payments to creditors, this can force some suppliers to cut off the supply of vital components or ingredients. Likewise, if you are unable to effectively collect payments it may cause future cash flow problems. Either way, sudden changes in these numbers should be investigated to see whether they are signs of something more serious. One important caveat to note is that COVID-19 has created many temporary accommodations by lenders, landlords, and suppliers. Extended terms based solely on business interruption are likely more manageable than systemic extended terms caused by other non-COVID-19 related factors.

Sign #4: High Interest Payments

Your lender is likely evaluating your creditworthiness on a regular basis. Large amounts of debt service and high interest payments could indicate poor financial health and be a sign your bank or other lender is suspicious of your viability. If lenders view you as high risk, funding debt will cost more. It is also a bad sign if lenders always seek stronger personal guarantees or security against any money they lend.

Sign #5: Falling Margins

Long-term survival for a business is more closely tied to profits rather than sales volume. Falling margins for a business suggest that costs are too high, and prices or income are too low. This is not a sustainable position.

Sign #6: Increasing Overhead Costs

When the business is thriving, it is easy to slip into a pattern of overspending. If money is in the bank, it may be easy to justify using it for capital investments, marketing, or more inventory. It is not a sign of financial distress to solely increase overhead costs. However, increased overhead costs without a corresponding increase in revenue may lead to financial distress.

Spending patterns may change throughout the season in your industry. Your spending might go up in the busy season. You need to be prepared to drop those expenses in the future when things start to slow down again. If you can see that your spending and overhead costs are increasing but your receivables are staying the same (or even decreasing), then it may be a sign of financial distress.

Sign #7: Sales are Decreasing

COVID-19 has created decreased business operations - and likely sales – for a significant number of businesses. If you don’t have money coming in through product sales, then it is time to figure out the problem. The failure to do so could lead to financial distress. The stagnation could be directly related to COVID-19, which means that you can anticipate that things will increase again in the future. However, revenue decreases could also be due to previous adjustments in your marketing campaign or a difference in the inventory that is available. It is essential to know what your customers need and want so you can be sure that your products and services are designed to match their needs. COVID-19 has created an opportunity for many businesses to pivot on how they deliver products and serve customers..

Sign #8: Customers are not Coming Back

Repeat customers are a sign of a healthy business. The lack of repeat customers could be a sign of financial distress. Company growth can be increased by the rate of repeat customers. Lack of growth coupled with one of the other signs of financial distress may create long term problems for a company.

To adapt to the COVID-19 crisis, you need to maintain communication with current and previous customers, helping them know where to go when it is time to make another purchase. Keep your company at the top-of-mind so customers know that you are always there to support them when they need help in the industry.

Sign #9: High Levels of Outstanding Receivables

Increased sales should be celebrated. However, if you are selling products and services and the outstanding receivables number is growing, then it could be a sign of financial distress. When your business profits are tied up in invoices that are outstanding, then you don’t have the cash in pocket that is needed to keep the company running.

The key is to ensure that customers understand the credit policies. Communicate the payment terms upfront, and then make sure that your team is consistent about following through on the collections.

Sign #10: High Turnover and Decreased Morale

Unfortunately, COVID-19 has forced many businesses to adjust labor and employment budgets. State and federal assistance through PPP loans has attempted to mitigate the need to lay off employees and incentivize companies to maintain existing payrolls. Temporary adjustments related to unique circumstances such as the current health and financial crisis may likely be a necessary survival tool rather than a sign of financial distress, but long-term difficulties in maintaining a happy and productive workforce could be an indication of trouble for the business.

If your company is experiencing any signs of financial distress, please contact one of the attorneys at Brennan, Manna & Diamond that are well-equipped to identify financial distress and help your company take corrective measures to get the business back on track toward success.

Michael A. Steel is the chair of the Financial Reorganization and Creditor's Rights team at Brennan, Manna & Diamond. He can be reached at masteel@bmdllc.com or 330.374.7471.