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Early Warning Signs and Viability Tests
Early Warning Signs are financial and non-financial measurements and ratios that can be graphed and the trend line monitored over time. The curve is either moving up, flattening out or heading downward. The challenge for 21st century management teams is to know the status of each critical measurement. 
When relied on exclusively, early warning signs are incomplete management tools. Some of the drawbacks are:
1. Hindsight is 20/20. It is easier to see the advent of decline after the fact than to predict it.
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2. A decline in one measurement, or |
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does not, in and of itself, |
3. Financial statements are snapshots of earlier periods and are lagging indicators. Management needs timely information and cannot wait for quarterly or even monthly financial data.
4. There is more to any entity than “the numbers”. Nonetheless, it all starts with the numbers.
Imperfect as they are, here is the bottom line on early warning signs and other performance measures:
“Organizations enter a state of decline when they fail to anticipate, recognize, avoid, neutralize or adapt to external or internal pressures that threaten the organization’s long-term survival.
In this definition we emphasize that the organization is already in a state of decline if decision makers are unaware of or insensitive to detrimental changes.”
Wow. An organization is already in a state of decline if management is not aware of unfavorable trends. That’s a heavy claim, but because of the increased availability of IT, and the increased levels of regulation and global competiton, it is even truer in 2009 than it was in 1991 when it was written.
21st century management teams cannot afford to be in denial about this: there is a fiduciary responsibility to owners and stakeholders to be “vigilant and use a proactive approach rather than be complacent and rely on crisis-based reaction.”
Contact Melissa Craig for an informal conversation if your company displays clusters of the measurements shown below OR if your company lacks the capacity to measure and track them.
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Sample Quantitative indicators:
| Decrease In: | Increase In: |
| Cash Flow from Operations (CFFO) | Debt as a % of Equity |
| Operating Profits | Working Capital |
| Net income as a % of Revenue | Days that Payables are Outstanding (DPO) |
| Market Share | Days that Receivables are Outstanding (DRO) |
| Cash Balances | Inventory |
| Revenues |
Non-quantitative indicators:
| Non-Financial: | Financial: |
| Staff Turnover → good employees leave | Cash flow runs the business |
| Suppliers withhold goods or demand prepayment | Constantly overdrawn bank accounts |
| Management constantly fire-fighting | Failure to produce financial statements/tax returns |
| Operational issues and problems | Failure to manage by financial data |
| Relationships with creditors/suppliers deteriorate | No current operating budget or operating controls |
| Personal guarantees demanded | Broken loan covenants |
Only about 20% of all distressed companies recover. Before making the decision to consume the remaining scarce resources on a failed turnaround effort, consider Professor Harlan Platt’s viability test. The entity must be able to answer “yes” to all three questions:
- Is there a core business, one that is currently generating positive cash flow, or that will be able to generate operating profits once unnecessary expenses are slashed?
- Is there available bridge financing that is sufficient to get the business to the point of operational break-even?
- Does the business have the operational resources to successfully undertake a turnaround. Is there a management team that has the ability to produce current financial data and expertise with the tools of turnaround management?
Contact Melissa Craig for an informal conversation if your company or a company that you have provided financial resources to, cannot answer "yes" to all three questions.
