6 Warning Signs of Business Financial Distress
by Robert J. Gonzales
Running a struggling company can be painful for owners and managers, and the ripples invariably impact customers, suppliers, vendors, and employees as well. There’s no magic to recognizing the warning signs of distress. Usually it’s more a matter of acknowledging the obvious. But business owners and managers can get so focused on working their way out of a problem that they fail to recognize how bad things have become.
Fiduciaries such as attorneys, accountants, and financial advisors have the opportunity and responsibility to help business clients acknowledge the distress and seek early guidance from a restructuring professional.
The following symptoms, while by no means dispositive, are clues that a company is struggling:
1. Stressed Out Management
Stress is a fact of life for most business managers. But, when ordinary business stress is combined with the pressure of financial distress, things can get truly harrowing. Owners of struggling companies often say they feel like they are drowning. Business stress can also be a factor in health and family problems. If you notice a business client or colleague who appears uncharacteristically ragged, have the courage to ask how business is going and encourage him or her to seek help if needed.
2. Borrowing to Cover Shortfalls
Borrowing money or injecting new capital as part of a well-reasoned business plan can be a critical ingredient in a successful venture. But propping up a struggling business through borrowing, capital infusions, or sales of assets is a different animal. Knowing whether such financing options are smart investments, or simply a last gasp, requires a determination of whether the business is viable in the long term. None of us has a crystal ball, but making an informed assessment about viability can be the difference between success and disaster.
3. Management Infighting
Financial distress is often related to disputes among owners and managers. Sometimes financial distress is the cause, and other times the effect. When a dispute arises, an owner or manager typically will seek guidance from his or her lawyer or accountant. The client may be asking for help only with the dispute, but an astute professional will also delve into the impact on the company's profitability.
4. Forbearance Agreements
Financial distress is the inability to meet obligations as they come due. So, if a business is negotiating a forbearance agreement with its lender, some hard questions must be asked. Lenders often use forbearance agreements to obtain concessions and waivers from borrowers in default, rather than moving straight to enforcement. Even if a business client is confident it can work its way out of trouble during a forbearance period, it should seek counsel from a restructuring professional before signing such an agreement.
5. Growing Payables
Nothing signals financial distress as plainly as slow-walking payables. If an accountant sees that payables are growing, or if an attorney is asked to defend collection actions (particularly if the company says it just needs to "buy time"), the subject of financial distress should be raised. Sometimes the unpaid bills are fees owed to a company's own lawyers or accountants. This can undoubtedly strain the relationship and diminish communication, but non-payment of professional fees is a fundamental warning sign of financial distress and should invite serious inquiries.
6. Payroll and Sales Taxes
Failure to remit payroll or sales taxes is an obvious, but all too common, sign that a business is in trouble. Payroll withholding taxes, or 941s, are comprised of two parts. The "trust fund" portion is part of an employee's compensation that is withheld from the paycheck and remitted to the IRS by the company on the employee's behalf. The other part is the matching funds required to be paid by the company. Sales and hotel taxes are entirely trust fund taxes because the company is required to collect the taxes and remit them to the state department of revenue; the money never belongs to the company. Since trust fund taxes are not property of the business, failure to remit them to the appropriate taxing authority is a serious matter. In fact, the person responsible for collecting and remitting trust fund taxes can be assessed personally for the unpaid amount.
Financial distress can be a difficult subject to broach. But encouraging a business client to seek help in the early stages of financial distress can greatly increase the client's chances for a return to profitability, or at the very least, for a soft landing.
Robert Gonzales guides companies through workouts and Chapter 11 reorganizations. He is a 1994 graduate of Vanderbilt Law School.