Alexandria, Va. — Commercial bankruptcies increased 21 percent in October, the twelfth consecutive month with a year-over-year rise in filings. An article in the November ABI Journal examines the warning signs of companies potentially facing financial distress prior to the public announcement of severe financial distress, fraud or bankruptcy. “Executives, financial analysts, investors, creditors and valuation experts often do not detect, or alternatively elect to ignore, these warning signs until it is too late,” Dr. Israel Shaked and Evan Altman of the Michel-Shaked Group (Boston) write in their article “Warning Signs of Financial Distress.”
Warning sings of financial distress can generally be categorized as either quantitative or qualitative, according to Shaked and Altman. Quantitative signs include an analysis of a company's financial data, trend or benchmarking performance to its competitors. The authors write that four types of quantitative metrics that experts often analyze in order to detect warning signs include, but are not limited to:
· Financial leverage ratios: “One of the well-known – but often overlooked – financial-leverage ratio is assets-to-equity, which indicates the relative level of debt financing supporting a company's asset base.”
· Liquidity ratios: “An analysis of a company's ability to quickly access the capital markets for cash to cover short-term obligations is challenging because it also requires an analysis of the conditions of the capital markets.”
· Activity ratios: “Various ratios can be used to identify warning signs, but two of particular interest are accounts receivable turnover and accounts payable turnover.”
· Profitability ratios: “Generally, there are two types of profitability ratios. The first type of ratio analyzes a company’s income-statement margins; the second type (return ratios) analyzes a company’s efficiency in generating profits by accounting for the investments made in the company’s operations.”
Quantitative signs include a change in earnings quality and questionable accounting practices, according to Shaked and Altman. “Even though a company may report earnings that beat analyst estimates and management guidance, the earnings may not necessarily provide a reasonable basis for determining future earnings,” they write. Shaked and Altman also write that, unfortunately, the choice of accounting policies can often be highly subjective. “An analysis of the footnotes and disclosures can help determine whether a company’s accounting choices are aggressive, ambiguous or fraudulent.”
“Even if the cause of financial distress is not disclosed in the financial statements, proper analysis could uncover warning signs that can lead to the identification of a larger problem,” the authors write. “Identifying and acting upon these warning signs prior to the company's announcement of financial distress or bankruptcy can create value, or avoid a further decline in value, for a wide range of stakeholders.”
To obtain a copy of “Warning Signs of Financial Distress” from the November edition of the ABI Journal, please contact ABI Public Affairs Manager John Hartgen at 703-894-5935 or jhartgen@abiworld.org.
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ABI is the largest multi-disciplinary, nonpartisan organization dedicated to research and education on matters related to insolvency. ABI was founded in 1982 to provide Congress and the public with unbiased analysis of bankruptcy issues. The ABI membership includes more than 12,000 attorneys, accountants, bankers, judges, professors, lenders, turnaround specialists and other bankruptcy professionals, providing a forum for the exchange of ideas and information. For additional information on ABI, visit www.abiworld.org. For additional conference information, visit http://www.abi.org/education-events.