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Detecting Distressed Businesses

Know the warning signs and when to take action

Every day, there are signals notifying us of an impending event. The traffic light changes to red, warning us to stop before traffic crosses in front of us; railroad crossing gates go down before the arrival of a train; or the smoke alarm goes off because something is very hot or on fire. All of these precursors are obvious and we know what to do for each occasion.

When you’re dealing with a company in financial distress, there are almost always indicators before everything goes awry. These precursors may be more subtle than the ones mentioned above, but being aware of the signs can keep you from being blindsided when a company files for bankruptcy, shutters its doors, or stops paying its customers or employees.

Early Symptoms
Among the earliest warning signs is slow pay or when a company doesn’t honor its obligations. “I promise to pay next week”—an owner might say, but next week comes and there’s no check or transfer. At this point, there is no need to panic, but accounts receivable staff should be concerned.

A number of years ago, Blue Book Services sent members a notice called “Seven Ways a Customer Becomes a Debtor.” John Burton, general manager of sales for Peter Rabbit Farms in Coachella, CA, cut it out and taped it to the wall next to his desk. To this day, Burton still refers to these warning indicators when doing business.

For the purposes of this article, we will review and update these caveats. Here are the seven warning signs—beware when a company: (1) breaks promises; (2) avoids phone calls; (3) asks to make partial payments; (4) has returned or nonsufficient funds checks; (5) requests copies [of invoices] constantly; (6) claims too many invoicing or pricing problems; and (7) uses you as a bank.

For his part, Burton provided another indicator for the list: a shakeup in staff, which can also raise eyebrows. “At one company, the comptroller quit, then two salespeople left,” he recalls. “I found out because the salespeople went to work for a competitor. When they called me for business from their new positions, I asked about the change and they told me their previous employer was in trouble. I made sure I got in line to get what money I could from the troubled company.”

Although it isn’t always the case, employees on the inside often know before outsiders when something is seriously wrong at their place of employment. They may be willing to share information, especially if they haven’t had a pay raise in a long time, the business has a hiring freeze, coworkers are already changing positions, layoffs are rumored, and overall morale is low. They’ll also know if the number of closed-door meetings has ramped up considerably.

Some businesses in trouble may cancel contracts with vendors and attempt to do the work themselves, like janitorial services or supplying coffee or other beverages. So when a trading partner’s accounting department doesn’t answer your calls or return them, it’s usually because there isn’t any positive news and talking to anyone makes them uncomfortable.