5 Signs Your Company Might Be Suffering from Poor Financial Health

eCapital Corp

Last Modified : Jan 23, 2024

Fact-checked by: Bruce Sayer

In challenging market conditions, business owners can get caught up in the rigors of overseeing operational activities as they concentrate on delivering products or services efficiently. As this focus is often all-consuming, monitoring the company’s financial health can be easily overlooked. While operations are crucial, financial health is equally important to remain solvent and for the long-term sustainability of the business. In too many cases, critical signs of deteriorating performance levels are missed until the company finds itself in financial distress.

Keep watch on your company’s financial health no matter how busy your day is. While a professional financial specialist’s thorough and regular analysis of financial statements is the best approach, business owners need to know what signs to watch for – you can’t manage what you don’t understand. With this knowledge, business owners can more effectively identify and respond to signs of declining financial health and proactively implement solutions to correct the situation.

Learn five signs that your company might be suffering from poor financial health and explore innovative funding solutions that could aid your business in returning to solid footing.

1. Cash Flow Issues

It’s a significant sign that your business finances may be in trouble if you consistently struggle to cover your operating expenses. Monitoring cash flow is crucial for a business’s financial health and stability. Calculating and analyzing key cash flow ratios is an essential aspect of good financial oversight, and can provide insights into liquidity and efficiency. Utilizing cash flow management software and tools that automate the calculation and analysis of ratios is the first core method to monitor your financial health. Although using software is a fast and simple way to track cash flow, you’ll also need to understand cash flow analysis to achieve a comprehensive and insightful examination and take corrective action if needed.

2. Increasing Debt Levels

While debt can be an essential tool for growth, a continual increase in debt levels, particularly short-term debt, can be the second indicator of poor financial health. Continually borrowing funds to cover basic operational costs is a warning sign of pending financial distress.

The debt-to-assets ratio is a commonly used metric to measure the percentage of the total assets of a company financed through debt. It measures a company’s degree of leverage, indicating how much debt is used to carry its assets and how those assets might be used to service debt.

Once you understand the concept of debt management, you can establish a target debt-to-assets ratio that aligns with your company’s financial goals and industry norms. This target should be based on growth objectives, risk tolerance, and the competitive landscape. Remember that the optimal debt-to-assets ratio can vary widely among companies and industries. But generally, a company with a high degree of debt leverage may find it challenging to stay afloat during periods of low growth. If you’re unsure about your company’s appropriate debt-to-assets ratio or need guidance on managing your debt, consider consulting with financial advisors, accountants, or industry experts.

3. Shrinking Profit Margins

Profit is vital to basic financial survival – monitoring profit margins regularly is critical to maintaining financial health. At a minimum, you should be monitoring the following ratios and metrics to gain insights into how efficiently your company is operating and how much profit it retains from its revenue after accounting for various expenses.

Net profit margin shows how much profit is generated from every $1 in sales after accounting for all business expenses involved in earning those revenues, including overhead, debt repayment, and taxes. Net profit is a company’s bottom line – the larger the profit margin, the better!

However, the net profit margin can be influenced by one-off items such as the sale of an asset, which would temporarily boost profits. Net profit margin doesn’t concentrate on sales or revenue growth nor provides insight into whether management manages its production costs. Therefore, it is best to utilize two more ratios.

Gross profit margin measures a company’s total sales revenue minus the total cost of goods sold (or services performed). This metric shows where a company can improve by cutting costs and increasing sales. A high gross profit margin is desirable and means a company is operating efficiently, while a low margin is evidence that some areas need improvement.

Operating profit margin is the ratio that calculates how much profit a company makes on a dollar of sales after paying for the variable production costs but before paying interest or tax. It is calculated by dividing a company’s operating income by net sales. Higher ratios are generally better, indicating operational efficiencies.

If your profit margins are shrinking more than industry norms or are constantly in the red, it’s a glaring sign of poor financial health and a call to action to correct inefficiencies.

4. High Inventory Levels

An efficient business balances customer demand while minimizing inventory costs. High inventory levels can be a hidden financial drain that ties up cash. It may indicate that you’re not turning over your goods fast enough. One way to assess a business’s inventory health is to calculate its inventory turnover ratio.

Inventory turnover ratio is a financial metric showing how many times a company turns over its inventory relative to its cost of goods sold (COGS) in a given period. Generally, the higher the ratio, the better, as it most often indicates strong sales. However, be cautious – a ratio that is too high may mean your company isn’t purchasing enough inventory to support your customer demand. A lower ratio can point to weak sales or decreasing market demand, which results in the goods being overstocked.

5. Reliance on a Few Key Customers

The last potential sign of financial health issues isn’t a metric but is, instead, a caution that if overlooked could drastically impact your success. While big clients are great for the top line, over-reliance on a few key customers can be risky. If a significant portion of your revenue depends on a single or a few customers, the default of an individual debtor can be ruinous.

A business may have a customer concentration risk if more than 10% of your revenue comes from a single client or 25% comes from a group of five of your most prominent clients.

Here’s how to calculate how much of your overall business is concentrated in one customer:

1. Calculate the total revenue from the client account in the past fiscal year
2. Divide that amount by your business’s total gross profits.
3. Multiply that number by 100 to find the percentage of your profits that the client contributes.

A high level of customer concentration can indicate a need for a more diversified marketing strategy to expand your customer base.

Take immediate action and maintain reliable cash flow

Identifying signs of declining financial health is the first step to keeping your business profitable. The second essential step is to rectify the problem(s) you’ve identified.

Following the above steps and taking immediate corrective action can help improve your company’s profitability. However, improved profitability does not necessarily equate to financial stability and health. Reliable cash flow is also required to achieve a complete picture of health.

In this tight credit market, traditional lenders are reluctant to approve SMEs for financing, especially if their financial health is in question. For most SMEs with underperforming financial levels, an alternate funding source must be found to maintain reliable cash flow.

Innovative funding solutions to maintain reliable cash flow

Recent reports show banks are tightening lending standards across the board, restricting credit on commercial and industrial lending. Fortunately, SMEs have a more favorable source of credit. Alternative lenders are structured to provide fast, flexible business financing solutions to businesses even if the banks have turned them down. Leading alternative lenders quickly process and generally approve financing to SMEs with creditworthy customers and unencumbered assets such as inventory, equipment, machinery, and accounts receivable. Easily accessible financing solutions offered by alternative finance companies are available to aid distressed businesses.

The following financing solutions are two of the most widely used and robust alternative financing solutions to unlock working capital and help businesses return to stability:

Invoice factoring: the selling of your company’s outstanding receivables to a third party at a discount in exchange for immediate cash.

Asset-based lending: uses your company’s assets, such as inventory, receivables, equipment, or machinery, as loan collateral. The loan is typically structured as a line of credit providing significant access to working capital.

Conclusion

No matter your business’s state or condition, you should constantly monitor its financial health. Recognizing signs that your company might suffer from poor financial health can help owners identify issues early, revisit business strategies, and make necessary adjustments.

Regularly analyze financial statements and watch for the five signs noted above to monitor your business’s financial health. If action is needed to correct declining levels, act quickly. Implement efficiencies to minimize output costs while maximizing revenue and secure alternate sources of financing if needed to ensure steady cash flow and reliable access to working capital. Struggling companies can regain improved financial health and stability by creating a culture of efficiency and continuous improvement supported by reliable cash flow.

Key Takeaways

• Critical signs of deteriorating performance levels are often missed until the company finds itself in financial distress.
• Keep watch on your company’s financial health.
• Learn five signs that your company might be suffering from poor financial health.
• Business owners can effectively respond to signs of declining financial health and proactively implement solutions to correct the situation.
• Achieving improved efficiencies often hinges on having steady cash flow and reliable access to working capital.
• Leading alternate lenders can provide reliable financing to businesses in financial distress.

eCapital Corp

eCapital Corp. is committed to supporting small and middle-market companies in the United States, Canada, and the UK by accelerating their access to capital through financial solutions like invoice factoring, factoring lines of credit, asset-based lending and equipment refinancing. Headquartered in Miami, Florida, eCapital is an innovative leader in providing flexible, customized cash flow to businesses. For more information about eCapital, visit eCapital.com.