If you have been in business for a while, you have developed a list of red flags that you watch for in tax return analysis or financial statement analysis. Good idea. And you are sharing these with the junior lenders you are mentoring. Another good idea.
Here are a few red flags that have perhaps changed colors.
1) Changing CPA firms. I wrote about this in a blog post in 2007. With Sarbanes Oxley there has been a lot of shuffling of CPA firms. A change does not mean they got fired because the CPA firm was worried about them. You can’t tell by looking…
2) Dramatic drop in discretionary expenses. This one used to be on my red flag list. Why would repairs, maintenance, advertising, or training take a dive? There are good reasons for all of them (they replaced equipment) and reasons that might indicate a cashflow problem.
What has changed?
Prudent businesses, including the one you work for, are taking a hard look at costs right now. How long until the recovery kicks in and takes hold? What cuts now will preserve our business and opportunities to be positioned for the turnaround?
It could be that this shows a pro-active business instead of one that is in trouble. Again, you can’t tell by a cursory look.
3) The bank they were with has restricted their credit. A business that has been ‘fired’ by their bank has always been suspect. In the current credit crunch, how do you tell the company whose bank has cut way back on even ‘good’ loans from a company whose bank has correctly recognized they are in trouble? Darn…can’t tell that one by a cursory look, either.
What other red flags might be changing color?