We often hear of companies getting into trouble when we tune in to financial news, and it seems there are myriad reasons why companies run into difficulties. In this article, I will be illustrating five simple tell-tale signs you can use to see if a company you’ve invested in is falling into trouble. These signs should be treated as red flags to be investigated further.
Sign 1: Falling revenues
When a company experiences falling sales, it could signal that it is losing market share, or that the industry it is operating in is not as attractive as before. Check the year-on-year percentage decline in revenue to see how badly the company is faring, and remember to also read the reasons as to why this may be so. The revenue decline could be due to stiffer competition, or the cancellation of orders from a major customer, among other possible reasons.
Sign 2: Declining margins
Margins are used to measure how efficiently a company prices its products (the gross margin) as well as how well it controls its expenses (the operating margin). If a company’s margins show a declining trend, it could signal that the company cannot price its products to capture more profits and/or that its expenses may be spiralling out of control. Both are negative developments and may portend further trouble down the road.
Sign 3: Increasing amounts of receivables
Receivables represent billings which the company has made for products sold, or services provided. Companies usually extend credit terms to their customers that range from 30 days to 60 days on average – this means that customers are given some allowance as to when they have to pay up. If a company’s receivables start to balloon, it may signal that the company’s customers are having problems paying up, and the company may end up with bad debts which have to be written off.
Sign 4: Growing pile of inventory
Companies buy inventory in order to sell it for a profit. In some fast-moving industries such as information technology hardware, some products may become obsolete fairly quickly. Obsolescence would show up in the company’s balance sheet as inventory which piles up as the items cannot be sold off quickly enough. This inventory build-up incurs storage costs for the company and the inventory may eventually have to be written-off; a write off will hit the company’s profit.
Sign 5: Significant amounts of write-offs or impairments
Watch out for companies which report large write-offs or impairments. These may relate to (1) failed acquisitions which did not turn out as well as a company had expected, or (2) assets which were purchased or built with the intention of generating more revenue but which eventually turned out to be white elephants. Though there may be plausible explanations provided by a company’s management for impairments and write-offs, it is always good to question the basis for the actions and to remain sceptical.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.