Ten Signs a Company has Financial Problems

In more than 20 years as a business journalist, my news judgment has been guided by a single principle: No company can exist in a permanent state of financial bliss.

Every corporation encounters problems that can snowball very quickly if serious amounts of money are involved. That is when the real drama begins. Top management is put to a test of character, leadership, resourcefulness and sheer guts.

As a financial journalist, it is up to you to keep your eyes wide open to the companies on your beat that might be encountering fiscal turbulence. Each company in trouble represents an opportunity for great reporting and award-winning coverage. But how do you know when trouble is looming?

A decade ago, I was invited to the University of Wisconsin to lecture on financial reporting. In preparation for one of my talks, I scribbled down a Top 10 list of signs that a publicly traded company has financial problems. That simple list has evolved into a valuable teaching tool. With minor modifications, the list could be applied to private companies, as well as non-government organizations. I shudder to think what would be the result if we applied it to the Social Security system.

1. Dramatic changes in corporate structure take place without a clear explanation of why. Many times a company that is headed for problems will try to make a funding shortfall go away by re-organizing its way out of trouble. This never works.

2. Fancy new headquarters opened. This is almost fool-proof. I do not know why. Enron would be a perfect example.

3. Large acquisitions do not result in rapid asset sales or a quick reduction of debt. Companies that make huge acquisitions must find a way to pay for them. If they do not, the wolves will soon be at the door.

4. Substantial deals take place between related parties, such as company officers and directors (sometimes regarding the real estate for the fancy new headquarters). See Enron, above. But also Adelphia Cable, WorldCom and Tyco Labs.

5. An older CEO remains in place without any clear succession plan. A.k.a., the Michael Eisner syndrome.

6. Footnotes to financial statements suddenly disclose regulatory investigations or a potential default on company debt. (For a privately held company, the disclosures might be in the form of a real estate lien or a suit for non-payment by a vendor.) There are plenty of examples of this, but the biggest two are WorldCom and Time Warner, which disclosed an enormous write-down as America Online got into big trouble.

7. A policy of "selective disclosure" is pursued regarding key balance sheet or income statement items. Banks that get into financial trouble are famous for revealing less and less to depositors. Ditto insurance companies.

8. Press releases or shareholder letters repeatedly open with revenue gains or new product launches but do not address fundamental declines in profit or rapidly rising administrative costs. A company that is doing well puts its profitability first. The only companies that really expect to lose money are early-stage companies that are trying to develop a new service or product.

9. A large societal/environmental issue arises in a company's industry and the company does not respond quickly to address it. Think about Disney's slow response to the Internet. Or the traditional telecoms' response to wireless. Or outsourcing.

10. A negative story about a company appears and management blames "a 26-year-old reporter who doesn't know anything about our business." As a reporter writing about an unfolding corporate calamity, you will get some heat. But you have the ability to talk to the company's suppliers, its competitors and its customers and get information that management can't buy for any amount of money.