When companies find themselves in financial distress they often wonder whether they could have prevented their problems by heeding some important warning signs. Companies rarely go into bankruptcy without some warning. While some of the signals may be subtle and go unnoticed, others are quite overt. Unfortunately, experience has shown that many of the signals are ignored or are detected too late. It is the subtle signals that occur well in advance of the bankruptcy that are important to recognize. Being aware of these signals can enable organizations to take steps or to engage the professional services necessary to prevent a bankruptcy. Taking action early in the process can translate into a win-win solution for the lender, government agencies, trade creditors and the debtor.

There are a number of early warning signs to alert businesses of pending financial problems. These warning signs can be categorized into Operational, Managerial and Financial signals.


Operational signals
Internal problems such as changes in senior management, high employee turnover and the resignation of members of the Board of Directors are a bellwether of trouble in an organization. The adverse impact of an unsuccessful expansion such as profitability coupled with insufficient cash flow, a lack of clear direction and a deterioration of internal controls is also a forewarning of potential financial distress. This typically leads to a decline in customer service, as quality is comprised to finance further expansion.

Other warning signs include one-time events such as a large bad debt or a warranty claim, the cancellation of a large order, a strike or uninsured fire or theft; changes in the market place, a change in supplier payments and pricing issues. A failure to keep abreast of technological changes or a change in consumer tastes can lead to product obsolescence and declining market share. Furthermore, a slowdown in payments to suppliers or court action by suppliers can lead to supply problems and an inability to meet orders. As well, businesses may offer customers large discounts for the early payment of invoices. Finally, underpricing contracts in order to boost sales and cash flow often leads to low or negative gross margins and losses.


Managerial signals
An inadequate management system, mediocre management skills and certain personality traits and habits are hallmarks of many bankrupt businesses. A management system that lacks depth and relies on one individual for decision making, creativity and marketing often leads to decision-making gridlock, an unbalanced management team, a lack of management depth and certain chaos. An inexperienced management team with weak financial and organizational skills as well as a poor understanding of finance and business may also foreshadow problems. Finally, the habits and personality traits of owners and senior managers such as not returning phone calls, working after hours, personal problems, and frivolous spending may hint at pending or future problems.

Financial signals
A decline in sales, lower profit margins, sustained losses, increased debt, a highly leveraged balance sheet, negative working capital and reduced cash flow are overt signals of financial distress.

A company's relationship with its bank and any changes therein is also a useful financial signal. Reduced availability on a company's operating line or a change in borrowing patterns may be indicative of financial problems. As well an increase in loan security or a bank's request for security on a previously unsecured loan is clear evidence of deterioration in the financial health of a business. Finally, the breaching of loan covenants or missed loan payments are clear warning signs that the company requires help.

Unique signals
While distressed companies experience many of the same characteristics, there are signals that are unique to retailers such as bookstores. New product orders may be cancelled or reduced. The frequency of sale events or advertising may increase as well as the type of sale. i.e. more half-price or liquidation events. Furthermore, stores may appear under-stocked or under-staffed. Finally, stores may appear outdated, run down or untidy due to a lack of funds for leasehold improvements.

Over the past few years the market and business model for bookstores has changed dramatically. The advent of superstores and e-commerce has changed the playing field. It is difficult for individual bookstores and small bookstore chains to compete with superstores and the Amazon.com's of the business world, particularly on the basis of selection and price. As a result independent bookstores have faced reduced sales, lower margins, and declining profits. Unable to restructure their business, some have either closed their stores or sought bankruptcy protection.

Luckily, some bookstore owners recognized the changing market place early and were able to diversify or differentiate themselves from their new competitors. Others consulted turnaround professionals to help renegotiate debt and were able to avoid bankrupting or closing their business.

Conclusion
While most companies rely on their financial performance as the key barometer of financial health, it is important not to ignore managerial and operational signals. Many profitable businesses have found themselves in trouble due to a rapid expansion (Bradless and Caldor Corporation in the US); an under financed expansion (Forzani Group Ltd); a changing market (Corel Corporation); or the introduction of a formidable competitor such as Wal-mart (Consumers Distributing, Kmart and the T. Eaton Company). In each of these instances the companies were successful before an operational event or unheeded signal led to financial problems and in some cases the subsequent failure of the company.

The businesses that were able to recognize early warning signs such as Zellers, Canadian Tire and The Bay have survived by differentiating themselves or changing and improving their business model.

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