Company in Decline

How to Recognize the Signs

For any trader it is important to know the company you are investing in: is it doing well, is it good idea to buy shares in the organisation now? How do you know if a company is on the slippery slope of decline? There are usually warning signs, from both within and outside the company.

The most obvious has to be falling revenues. If this happens as a one off it may not be significant, especially if it is linked to a turn of events in the economy. But if you start noticing a pattern of falling revenues over a period of time, with each quarterly review significantly worse than the last, this is evidence that things are not right. This goes hand in hand with growing losses, which occur when the company’s revenues are surpassed by expenditure. Again, if there is a consistent pattern of increasing losses, either through falling revenues, rising expenses or a combination of both, then this is a bad sign that it may be only be a matter of time before that company goes bust.

Rising debt is another clue to look out for: if a company has to continually borrow money to sustain even its very basic operations, then there is a problem, which gets worse if a company has to approach the capital market in order to obtain funds to take care of its debt. If the company’s debt profile continues to increase with no sign of stopping, this is worrying. A company’s liquidity is important, because a decrease signifies that the company is running out of cash. Short-term loans can occasionally cover short terms of trouble, however, lenders will only give to companies they feel are credit worthy, therefore if a company is refused overdrafts or loan facilities, this is usually a red alert that all is not well with the company’s finances.

Many investors get caught out because they do not pay particular attention to what is going on within the company. They mostly rely on share prices which in themselves can be very misleading. But there are some warning signs from inside a company which can be a clue that the company heading in a downward spiral.

Boardroom arguments are usually a sign that all is not well within the organisation, particularly if a member of the financial team, such as the CFO, has resigned or been forced out. Investors should pay particular attention to whether there is something unlawful going on that is being objected to etc. In general, internal rivalries and ceased communication are negative signs. When information stops flowing, people avoid conversing; when decisions are made in secret, this is a clear sign that things are in trouble. People mistrust official statements – that is when gossip begins to replace the facts… which is never a good thing.

It follows that lack of communication leads to increased isolation: people retreat into their own corners or cliques, often suspicious of others and unwilling to engage with them. Withdrawing from contact discourages others from engaging with them too. Focus turns inwards, people stop looking at the bigger picture, and external goals become lost. Criticism and blame increase, external forces are blamed, personal responsibility is avoided. Respect decreases, along with initiative, and subsequently aspirations diminish. People stop improving and instead simple settle for minimising risk. It is no wonder that negativity spreads.

All of these are parts of a negative – often emotional – chain reaction, which drags the company into further decline and distress. It is essential to pick up on the warnings, both inside and out, in order to avoid investing in a company which is heading for disaster and unable to recover.