Skip to Main Content
Services Talent Knowledge
Site Search
Menu

Alert

Our attorneys stay on top of changes in legislation, agency regulations, case law, and industry trends—then craft timely legal alerts to keep clients up to date on legal developments important to their business.

November 17, 2022

Red Flags That a Company May Be in Financial Trouble, Part 1

It can be disruptive and expensive when a company you do business with (a customer, a supplier, a tenant, a borrower, etc.) closes its doors or files for bankruptcy. There may be steps that can help mitigate the damage, but to be effective, these steps must be taken, or at least commenced, before the business is in bankruptcy or closes. It is critical to know as early as possible if a company you are doing business with may be in financial trouble.  

This alert, and Parts 2 and 3 to follow, describe some of the red flags that indicate a company you do business with might be in financial trouble or at risk of filing for bankruptcy. The list includes factors applicable to a number of types of business relationships, so not every factor will be applicable to your particular relationship. While the occurrence of one or more does not necessarily mean a business is or will soon be in trouble, they should at least cause a heightened awareness and, if possible, some additional inquiry and investigation to attempt to determine if the company with which you are doing business has financial issues that may make it unable fulfill its obligations.

1.    Industry Particularly Hard-Hit by the COVID-19 Pandemic 

Some red flags are not particular to the specific company but involve broader events or conditions. For example, anyone doing business with a company in an industry that was severely impacted by the COVID-19 pandemic should remain on heightened alert for future problems.

2.    General Market or Economic Problems or Changes

Aside from the COVID-19 pandemic, a number of general economic problems or changes (e.g., shortages, large price increases for certain materials or components, new government regulations) affect some industries more than others. 

3.    Changes in the Marketplace

Occurrences particularly affecting a company, such as new competitors, new products, product obsolescence, changing consumer preferences, and changes in government spending, may be the forerunner of upcoming financial problems. This could also include political and/or public perception risks, such as when a product is considered harmful or an industry contributes to environmental issues or climate change.

4.    Late or Partial Deliveries

While late or partial deliveries of ordered products occasionally occur, repeated or frequent occurrences could be evidence that the company has insufficient operating funds, employees, or supplies or has other problems.

5.    Request for Change in Payment Terms 

Although there are other possible reasons, a request for a change in payment terms could be evidence of a temporary shortage of funds or larger, longer-term problems.

6.    Large and Unusual Decrease in Purchases

This type of deviation from a company’s normal purchasing patterns could be caused by a significant drop in sales, lack of funds, or other problems.

7.    Large and Unusual Increase in Purchases

Although it seems counterintuitive, sometimes a company in deep financial trouble will purchase large amounts of merchandise, raw materials, and supplies right before an anticipated bankruptcy filing to stockpile items necessary to operate the business during the early stages of the bankruptcy case.

8.    Major Customer’s Financial Difficulties

For a company that relies on sales to a small number of customers for a significant portion of its business, a bankruptcy, failure, or other significant financial problems with one of those major customers often leads to financial problems for the company.

9.    Major Supplier’s Financial Difficulties

Similarly, if a company relies on one or a small number of suppliers for inventory or critical or unique raw materials or components, financial problems with one of those major suppliers often leads to financial problems for the company.

10.    Labor Issues

While labor disputes are sometimes easily and quickly resolved, sometimes they can cause short-term problems or even severe long-term damage to a company’s financial health. Also, layoffs or hiring freezes can be an indication of reduced business, cash flow issues, or other problems.

11.    Litigation

Litigation can be a regular occurrence for some types of businesses and is not necessarily damaging, especially if covered by insurance. However, some litigation, due to its size or nature, can financially cripple a business, significantly interfere with its ability to operate,  severely damage its reputation in the market, distract management, or all four. This can be especially true of certain types of class action litigation, disputes involving regulatory matters, and criminal charges or investigations.

12.    Approaching or Exceeding Credit Limits

In a business arrangement in which a company has credit limits (or borrowing limits), if the company begins hitting or exceeding those limits, this could be a sign of lack of liquidity, problems with sales or collections, or other problems. Conversely, it could be an indication of growth and the company’s need for greater financing, so further inquiry is needed. 

13.    Missed, Late, or Partial Payments

Missed, late, or partial payments are almost always a sign of a company’s financial difficulties. While there may be a plausible and reasonable explanation for an occasional missed, late, or partial payment, it is likely that a company’s problem with multiple payments is a result of larger issues.

14.    Overdrafts and Bounced Checks

Overdrafts and bounced checks are even more problematic. In addition to the problems with missed or late payments, they are evidence of, at best, a company’s lack of proper financial controls and, at worst, a lack of business ethics and integrity.

15.    Later-Than-Usual Payments 

Although not as obvious, if a company typically pays immediately and its payments begin coming in much later, even if still within the payment terms, this could be an early indicator that the company is having cash flow or other problems.

These are just a few of the signs that a company you are doing business with might be in in or heading for financial trouble. Be on the lookout for additional red flags in Part 2.

The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com, or Janice Grubin or Jeff Dove, co-chairs of the Restructuring, Bankruptcy & Creditors’ Rights Practices Area, at jgrubin@barclaydamon.com and jdove@barclaydamon.com
 

Subscribe

Click here to sign up for alerts, blog posts, and firm news.

Featured Media

Alerts

Northern Long-Eared Bat Granted Federal Endangered Status

Alerts

USFWS Proposes Revision to African Elephant 4(d) Rule

Alerts

Red Flags That a Company May Be in Financial Trouble, Part 2

Alerts

NYS Governor Hochul Signs Bill Requiring Posting of Veterans' Benefits and Services

Alerts

Office of Cannabis Management Preview of NYS Adult-Use Cannabis Regulations

Alerts

Moving Defendant Relying on a Complete Defense Need Not Disprove Every Exception

This site uses cookies to give you the best experience possible on our site and in some cases direct advertisements to you based upon your use of our site.

By clicking [I agree], you are agreeing to our use of cookies. For information on what cookies we use and how to manage our use of cookies, please visit our Privacy Statement.

I AgreeOpt-Out