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Forget About Crooks, Start Worrying About Good Guys

Edward Hostmann

In this time of corporate governance run wild, it's easy to assume that some form of fraud lies at the root of most company failures. But in reality, very honest people sometimes make catastrophic mistakes that bring a company to its financial knees. It's important for the investing public and lending institutions to be aware of the signals sent out by a company in distress, when good intentions are producing bad results. Here are some symptoms of imminent trouble that should not be ignored:

1.  The company is hemorrhaging cash. In the end, cash flow is a very simple concept. If there's substantially more money going out than in, there's a problem. Even if a company is profitable, it may be bleeding cash at the same time, which is a warning sign that should not go unnoticed.

2.  Management's thinking has retreated into the bunkers. When the big picture becomes unbearably bleak, management tends to retreat into old dreams of better times and avoids present realities. At the same time, a company's leadership is inclined to focus on small problems, where they still have some measure of control.

3.  Relationships with lenders have turned rocky. Lenders tend to quickly see through a financial fog and realize that more money won't address root problems. Conversely, management thinks a little cash is all that's needed to get things back on track.

4.  The best people are heading for the door. In many cases, the ineffectual and the mediocre are the primary population left in a company on the way down. Eventually, the talent pool shrinks to the point where the company has lost its ability to survive.

5.  Tactics have completely pre-empted strategy. In a time of corporate crisis, management is drained by the struggle to simply stay afloat. Micro-scale issues, like pleading with suppliers, dominate. Macro-scale issues, such as declining infrastructure, become invisible.

6.  Employee morale is heading south. Eventually, the symptoms of negative cash flow are apparent all the way up and down the organization. Machines break down. Irate vendors quit shipping. Workers lose faith in management's ability to run the company. The situation is often exacerbated by management retaining highly visible perks while the company is in a state of obvious decline.

7.  Payables are stretched to the breaking point. What starts as a small delay in paying bills to conserve cash eventually turns into payments so late they threaten the ability to do business at all. Vendors of critical components or services demand cash on delivery—or worse yet, cash in advance.

8.  Quality problems proliferate. A cash-starved company puts off non-essential expenses, such as upgrades, improvements and maintenance of critical equipment or processes. Ultimately, this creates quality problems that erode the company's position in the marketplace and shrink sales.

9.  Late shipments are increasing. Declining infrastructure and slow vendor deliveries ultimately take their toll on production schedules. Late shipments lead to declining market share and forced discounting. The result is a dwindling revenue stream that puts even more pressure on a company's constricted cash flow.

10.  Attempts are made to "buy the market." With late shipments and quality problems mounting, a company will resort to extreme marketing tactics to compensate for declining market share. Steep discounting and low-interest financing are typical tactics in this situation. Faced with reduced revenue versus no revenue, companies opt for the lesser of two apparent evils.

Once this set of symptoms is in place, a powerful downward spiral begins, and it becomes very difficult for a company to stabilize itself without outside intervention. Often, drastic action of this kind becomes the only practical option when primary lenders and investors discover too late that they're dealing with the best of business intentions gone wrong.

This opinion piece was published in The Business Journal of Portland on December 20, 2002. http://portland.bizjournals.com/portland/stories/2002/12/23/editorial3.html