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How to tell if a company is heading for trouble

Last week on this page we discussed the “dead-horse strategy.” There is only one sensible strategy to follow if your horse is dead: dismount. Many of us, nonetheless, don’t do sensible strategies: we try to fund, motivate, whip or imagine the dead horse back to life.

The column raised many a laugh, but also a recurring question: how do you know, earlier on in the story of the horse’s life, that it may be headed for death? So that you can act before you find yourself straddling a corpse?

Given how often I was asked that question last week, I thought owed you an answer. So here we go.

It is indeed true: organizations are not quite the same as horses. The latter stop moving and breathing when dead; the former can continue to give the semblance of life even though clinically defunct. Even when the company is on the deathbed, it can often continue to keep paying (some) employees and suppliers, and selling things to (some) customers.

So how do you tell before the company enters ICU that it is likely to end up there?

Let me share some of my own pointers with you this week. These are the warning signs I look out for that foretell trouble to come. When a company you work for, supply to, buy from or invest in starts exhibiting these symptoms, be worried.

The first one is about its bankers. If a business is perpetually changing its banking partners, it’s telling you something. When credit lines are exhausted and relationship managers have lost patience, bad customers often start looking elsewhere. So take a hard look at the history of banking relationships. How many banks added or changed in the past five years? And if you are a tier 2 or 3 bank that’s unexpectedly contacted by a top corporation you couldn’t even approach in the past…be especially circumspect.

The second signal comes from auditors. Is there a stable auditing relationship in place? Or are auditors always being dropped a bit too frequently, because they are asking too many pesky questions? And if a there is a long-standing auditor in place, is the audit fee uncommonly large? There is, sadly, a long history of rogue auditors in respected firms being paid more than their work deserves, simply to look the other way when figures are massaged.

A third pointer: pay more attention to gross margins than revenues. A stable realized gross margin suggests a strong competitive position: customers are willing to pay the asking price, because they get enough value back. A company with ever-diminishing margins on its key products is telling you something else altogether: that customers are increasingly reluctant to pay the expected premium, and have to be ‘bribed’ to buy with lower prices and discounts and special offers or loyalty programmes; or that costs of production or distribution are spiralling out of control. So top line can be growing and painting a misleading picture. Look at the trends in the margins of key products instead.

Fourth signal: look out for deep-seated arrogance. CEOs who preside over monumental failures often exhibit the sin of hubris: they brook no dissent and cannot imagine any misjudgements on their own part. Poor results are usually blamed on external factors, and weak returns are just denied or glossed over. Weak CEOs usually make their weaknesses obvious, and get replaced early. Arrogant ones often give the deception of confidence, and stay on in office too long, with mistakes multiplying, until it is too late. Way too late.

Lastly, watch out for the absent CEO. If the chief officer prefers the golf course, cocktail circuit or conference appearances to actually running the business with heart, soul and full attention, pain will follow. Bosses who prefer the glamour of the job to its gritty details will not see trouble coming.

There you are, then: some simple pointers that herald problems to come. Paying attention to them may help you dismount before the horse stops moving. Or to take early action to rescue the horse from an untimely demise.

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