INVESTORS and business people trying to assess the credit quality of other companies can assess a range of financial and non-financial indicators. John Carello, the reconstruction and advisory services partner at accounting firm PKF, said warning signs
INVESTORS and business people trying to assess the credit quality of other companies can assess a range of financial and non-financial indicators.
John Carello, the reconstruction and advisory services partner at accounting firm PKF, said warning signs of business failure included poor management, over-trading, excessive gearing and a lack of financial data.
Indications of poor management included a domineering chief executive, an uninvolved board of directors, and a weak finance function.
The problem of over-trading refers to firms that pursue rapid growth but fail to ensure they can fund the growth or manage the increase in transactions.
A classic example of excessive gearing is the use of a $2 company with no equity and 100 per cent debt.
Mr Carello said a business unable to provide regular financial information was likely to exhibit some difficulty.
Information that should be available on a timely basis includes monthly financial statements, a listing of debtors and creditors with terms of payment, and budgets with appropriate analysis.
Key financial ratios include the level of gearing (debt to equity) and the ratio of current assets to current liabilities.
The availability of financial data has generally been enhanced by the requirement to lodge monthly or quarterly BAS returns.
Mr Carello said some businesses may be “asset rich” but still had inadequate cash flow, and would therefore be unable to pay debts as and when they fell due.
“Directors can be lulled into a false sense of security because of their strong assets, only to find they cannot purchase the raw materials to feed these assets,” he said.
“Even a temporary lack of cash can spell disaster as it has the potential to destroy the market’s confidence in a company.”
As such, it is critical that management has reliable cash flow projections.
A sign of financial pressure may be where companies extend the term of their payments to creditors.
Mr Carello said there was a range of non-financial symptoms that provided warning signs of company failure. These included falling company morale, loss of key personnel and deterioration in the appearance of personnel.
“There is no substitute for attending client premises and seeing first hand how the company is going,” he said.
Disputes among key management and involvement in legal action were other signs of potential trouble.