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10 warning signs you could be heading for financial trouble

Learn how to avoid some of the most common challenges facing business owners.

11-minute read

Some warning signs of financial hardship in business are obvious, others are more surprising. Knowing how to recognize them can help business leaders deal with the situation before it gets out of hand.

Meeting with business leaders facing financial hardship is all in a day’s work for Caroline Comiré, Assistant Vice-President, and Karina Amram, Director, Business Restructuring, BDC. They know the risky situations that can result in restructuring like the back of their hands.

Comiré and Amram share these 10 warning signs of financial difficulties for small and medium-sized enterprises (SMEs) and offer advice on how to avoid these pitfalls.

1. Uncontrolled growth of the business

Companies are constantly seeking growth, but the rate of expansion must be controlled to avoid hitting a wall.

“Rapid sales growth comes with cash flow challenges because, for example, the company has to build its inventory in anticipation of sales,” says Amram. “Greater flexibility is needed, along with a corresponding higher borrowing capacity. If everything is moving very fast, however, employees may have trouble getting financial information out to the banker, who may not be able to keep up with the company at the required pace.”

Rapid sales growth comes with cash flow challenges because, for example, the company has to build its inventory in anticipation of sales.

Managing logistics is also difficult during rapid growth. “Companies end up having to rent warehouses quickly and find transportation, in addition to having to hire new employees,” explains Amram. “And, when it’s urgent, everything costs more, and decisions made aren’t always the best.”

Some companies also decide to expand their factory to meet demand. “A company at 90% capacity might decide to double its floor space, for instance,” adds Comiré. “But, once the expansion is complete, less than 50% of the space will be used temporarily while growth materializes. It’s a risk because it represents significant additional costs.” 

For example, this rapid growth can occur when a company’s products begin to be distributed through a large retail chain. “If the company can't honour its contracts because it can’t source enough supplies, it will have to pay penalties,” says Comiré. “In the end, these contracts will not be profitable and may even cost the company money. It can be a slippery slope.”

How to avoid difficulties when growing rapidly?  

You need to make sure to grow at a pace that you can keep up with, even though moving very fast can be tempting. “It's important to know how to surround yourself with the right people to grow successfully and ensure that you manage your cash flow, your line of credit and your other resources well,” explains Amram.

2. A business acquisition that doesn't go as planned

When making an acquisition, integrating new companies takes time and funds, especially if they were in bad shape financially.

The challenge of integrating corporate culture is usually underestimated. “The strength of a company is often its people,” says Amram. “If employees do not adhere to the same values and vision, integration will be difficult and there will be an impact on operations. The hardest thing to change is corporate culture.”

Synergies are often overestimated in acquisitions. In the automotive industry, for example, in a case where a dealership for one brand acquires a dealership for a different brand. “Ultimately, each one needs to have its own maintenance department,” Comiré explains. “If a new car dealership wants to acquire a used car dealership, it will quickly become apparent that the supply networks are very different. In the end, many expected synergies do not come to fruition, or do not appear as quickly as expected, especially when the analysis of the business opportunity and due diligence were not very thorough.” 

How to avoid problems with a business acquisition?

It’s important to invest time and money to thoroughly review the financial records, legal issues and market positioning of the business you want to acquire. Completing due diligence can save you from costly surprises after the acquisition.

The due diligence process will also help you plan for the integration of your new business.

3. Changes in management tools

Having efficient management tools is essential for a company’s survival, but setbacks are common during their implementation. “Management tools can cost much more than expected and can cripple a company’s information systems if their implementation is not planned properly,” says Amram.

Employee resistance to change also should not be underestimated.

How to ensure the successful implementation of a new management system?

“The first step in making a change is properly communicating the change and demonstrating to employees how adhering to the new management systems will benefit them,” says Comiré.

When you train your people well, the results can be extraordinary. Training therefore does not represent a cost, but rather added value.

Training is also essential to make these investments profitable. “Often, a company has great systems, but people don’t know how to make full use of them,” says Comiré. “When you train your people well, the results can be extraordinary. Training therefore does not represent a cost, but rather added value.”

4. High debt levels

“Within an industry, some companies always have more debt than others,” says Amram. “Companies with high debt levels have less flexibility and are therefore more vulnerable to the unexpected. On the other hand, companies with less debt can seize opportunities that others cannot. It is also important to know that the more debt a company has, the higher its loan interest rates are likely to be.”

Companies with high debt levels have less flexibility and are therefore more vulnerable to the unexpected. On the other hand, companies with less debt can seize opportunities that others cannot.

The debt structure must also be well balanced between short and long-term debt. For example, when a company carries out a project, it obtains a long-term loan which might not cover unforeseen circumstances and cost overruns. “The company needs to cover these, and management might use the line of credit to do so,” Comiré explains. “The use of the line of credit then quickly exceeds the company's borrowing capacity, given that the line of credit is meant for the company’s day-to-day operations.”

How to avoid over-leveraging?

Debt should never be taken lightly. “Before investing further, always make sure to maximize existing assets. When analyzing a project, it is important to allow for enough potentially unexpected costs and to establish an adequate funding structure at the outset. It would also be wise to leave the profits in the company to have more room to manoeuvre during leaner times.” 

5. Poorly planned business succession

There is great admiration for businesses that are passed on from one generation to the next. They face many challenges, however.

For example, there may be conflicts between shareholders within the same family. “Often this will prevent them from running the business effectively,” says Amram. “Emotions come into play and making good decisions by reaching a consensus quickly becomes complicated.”

Often, those next in line are ill-prepared. Comiré notes that many strong family businesses face major problems because parents want their children to take over at all costs. “Often times, highly motivated, key employees in these companies are not family members,” says Comiré. “These employees disagree with the arrival of new leaders, whom they perceive as not having the skills to do the job. The situation quickly becomes problematic, and key employees leave.”

How to execute a successful business succession?

A succession plan is a proven way to reduce disruptions when handing over the reins of the business to the next generation. Having a plan in place will give you the opportunity to discuss the details of the sale with your bank and give you time to deal with the human side of the succession. 

Remember to ensure that the family member becoming the new CEO is prepared to take on the role. Comiré suggests, “putting key people in place around the children to support them.”

6. Cyclical or difficult industry

Cyclical industries, such as the lumber and mining industries, or industries with declining market relevance, like the compact disc industry, also come with their share of risk.

“Companies in cyclical industries have particular financing issues and often experience significant variations in their financial position over time,” mentions Amram.

How to avoid trouble in a tough industry?

When running a business in a cyclical or difficult industry, you need to be doubly careful to better manage cash flow during the inevitable downturns. Creativity can also provide a good boost.

“For example, a company that makes plastic sleds for the winter could use the same distribution network to make plastic shovels for gardening in the summer,” suggests Comiré. “You have to do everything you can to reduce risk and maximize resources.”

7. Organizational problems

Entrepreneurs often carry the weight of their business on their shoulders. But it can become a slippery slope when personal problems arise. “Shareholders that are hard to reach during business hours, several employees that leave, or a third CFO hired in two years are hints that something might be wrong,” says Comiré.

Attention must also be paid to diversifying the customer base. “Some companies have one customer that accounts for 40% of their sales,” says Amram. “They become dependent on this customer, and if the business relationship suddenly breaks down, it becomes very difficult for the company to recover.”

How to avoid organizational problems?

A business leader should have a board of directors or an advisory committee. “Knowing how to surround yourself with people who have different experiences is key,” says Comiré. “Entrepreneurs must find people who excel in areas that are not their strengths.”

Creating a strategic plan is another exercise that can mitigate risk. “Many entrepreneurs run their businesses on instinct, and that may be fine for a small company, but it becomes problematic as they grow,” says Comiré. “You see leaders of larger companies who lack adequate strategic planning or financial forecasting and who cannot effectively adapt when challenges arise.”

8. Financial management issues

Poor financial management usually leads to serious problems. “It’s worrisome to see a company that doesn’t produce monthly financial statements or financial forecasts,” says Comiré. “When profitability suddenly drops, this makes it hard to determine the exact causes and to adapt quickly.”

For example, some executives may not realize that they are maxing out the line of credit several months in a row. “Chartered banks, however, are quick to raise a red flag when this happens,” adds Amram.

How to avoid financial management issues?

Implementing efficient financial processes will help you streamline your business operations and get the information you need, when you need it. Having good safeguards and controls in place is also essential to mitigate risks (cash management, fraud, incorrect costing, underpricing, etc.).

Always knowing how your financial situation is changing is key. You need to have a dashboard with several performance indicators.

“Always knowing how your financial situation is changing is key,” Comiré explains. “You need to have a dashboard with several performance indicators. Among companies facing hardship, even those with $100-150 million in sales, very few have an effective dashboard.”

9. Problems related to the external environment

Several aspects of the external environment can pose risks, such as a highly regulated industry, remoteness from markets and fierce competition. The risk of legal action or negative media coverage should not be overlooked either.

“And of course, there’s the risk of a pandemic outbreak!” says Amram.

How to avoid problems related to the external environment?

Completing a analysis of your external environment as part of a strategic planning process will help you identify the latest trends, analyze your competitive environment and establish strategies to respond to potential threats that may lie ahead.

It is also important to keep an eye out for radical technologies that could disrupt your industry.

10. Undue optimism

Business leaders may also adopt a form of undue optimism when faced with some disturbing facts. “They say, for example, that they’ve been through tough times before and that they’ll manage it again this time,” says Comiré. “But times have changed, bankers are not the same these days, and things can get out of hand.”

How to avoid undue optimism?

Entrepreneurs must remain constantly vigilant and ready to respond, especially given that acting quickly when a company is in trouble can make the difference between bankruptcy and a successful restructuring. To recover from a precarious situation, you must quickly address the issues and communicate transparently with your financial partners.

“All entrepreneurs face financial challenges at some point in their careers, and that’s normal,” says Comiré. “This experience helps them develop skills and resilience that make them better entrepreneurs and managers later on.”

Learn more about managing your finances by downloading our free digital cash flow management guide.

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