How to tell if a company is failing

Mark Hoppe shares 10 key warning signs that, in combination, could mean a potential customer isn’t worth the risk of doing business with.

Doing business with other businesses has always involved an element of trust. Companies often provide goods and services based on a promise from their customer that they’ll pay within the credit terms. Both parties have to operate in good faith but sometimes, for various reasons, customers are unable to pay. When customers pay late or not at all, this can compromise your cash flow and make it difficult to continue operating as normal. 

Many companies operate blindly, defaulting to trusting customers until customers don’t pay. That’s a risky proposition and can result in losses that can quickly get out of hand. Businesses should consider taking out trade credit insurance, which can protect the company if customers don’t pay. It can also help businesses do more thorough due diligence before deciding which customers to trust. 

Choosing the right companies to do business with is a key ingredient in avoiding the cash flow issues that can result from non-payment. It’s important to understand the warning signs that could indicate a potential customer could cause a problem by not being able to pay. 

We’ve identified 10 key warning signs that, in combination, could mean a potential customer isn’t worth the risk of doing business:

1. Too much debt: if a company’s operations are mostly funded by creditors instead of the business owners, and it may have some difficulty servicing that debt, then it is under stress and may not be a valuable business partner. 

2. Over-expansion: if the business has expanded faster than its cash flow would allow, by taking on debt to fund the expansion, then there is risk present, even if the business owners have experience and know what they’re doing. 

3. Lack of clarity: if it’s not clear what the business does or how it generates cash, there is likely to be a significant amount of risk. These types of businesses should be avoided. 

4. Qualified accounts or going concern commentary: qualified accounts are audited accounts where the auditor has doubts or disagreements with the firm’s management. Going concern commentary is not as serious as qualified accounts but it can be a sign that the auditor is protecting themselves from litigation but is still signing off on the accounts. This is a huge red flag; don’t do business with a company showing these warning signs. 

5. Profit warnings: a profit warning is the clearest sign that a company won’t meet its earning expectations and could be a signal that the business may be in trouble. 

6. Profit versus cashflow: a company with strong profits but little cashflow could be hiding issues and can be a sign of dodgy accounting practices. Doing business with such companies carries strong risk.

7. Irregular payments: If payments are slipping or becoming irregular, or even coming in lumps after long periods of non-payment, it’s a sign the company’s cash flow is compromised. Deciding to continue doing business with a company in this situation can depend on past payment history, current relationships, and the reasonable likelihood of the business getting its cash flow back on track. 

8. Unstable leadership: if there are lots of changes or signs of discontent at the board or leadership level, such as surprise resignations, this could be a sign of trouble ahead. 

9. Trappings of success: when directors have high-end, brand new cars, computer systems, and furnishings, it can be a sign that directors are rewarding themselves at the expense of the company. By itself, this isn’t necessarily a sign of trouble, especially if cash flow is strong and the company is meeting all of its payment obligations. However, taken in conjunction with other signs on this list, this could be a red flag. 

10. Late filing of accounts: if the company files its accounts late, it could be a sign of general disorganisation or it could indicate that the business had trouble getting an auditor to sign off. 

As in most aspects of business, context is everything. One or two of these signs in isolation may not be conclusive evidence that a company is failing. However, when enough of these signs come up together, or when the circumstances are especially severe, it’s a strong warning that your company shouldn’t do business with this customer. 

Mark Hoppe is managing director-ANZ of Atradius.