The concept of early warning signs has been around for a long time and can be applied to many activities. There are warning signs in medicine, politics, personal and business relationships, as well as almost any other category. When relating to business performance, warning signs apply to distinct functional areas. Unfortunately, many companies suffer from critical problems that could have been avoided if the early warning signs had been observed and addressed.

Typically, the origin of a crisis can be traced back two or three years before its onset, when the initial problems began to surface. In many situations, top management is in a state of denial and relies on rationalizations and quick fix answers to issues that are fundamental to the success of the business.

This list of 50 Warning Signs, which is divided into six main categories, can provide management, board members, owners, bankers and other investors, a tool to help focus attention on those problem areas which can, if not dealt with, develop into much deeper and more costly crises. While this list can be applied rather broadly to most businesses, every company and industry will have early warning signs which are unique.

1. Sales Characteristics

• Have you had a significant sales forecast shortfall for three or more months?
• Does your sales forecast show expectation of sales increases in excess of current levels or prior year performance for the same period?
• Is your sales forecast based on growth rates which are greater than the industry is expected to grow?
• Did you increase your sales forecast in order to assure that all overhead expenses would be fully absorbed?
• Do current or projected sales volumes anticipate the sale of greater amounts of low margin product or the addition of new low margin customers? (Incremental sales!)
• Are there negative trends in industry pricing practices?
• Has your business experienced a decline in market share during the past two years?
• Are sales concentrated with customers who are experiencing financial or operational problems?

2. Cost Characteristics

• Have selling, general and administrative (operating) expenses shown continued increases as a percent of revenue or grown faster than revenues?
• Have gross margin percentages declined for three consecutive months?
• Are executive salaries and prerequisites greater than industry norms?
• Have actual costs exceeded budgeted costs for three consecutive months?
• Does the company need better cost monitoring and measuring against budget and prior periods, and more accurate reporting on a timely and consistent basis each week or month?
• Does the company need better cash flow monitoring and/or forecasting?
• Does the company need better capital expenditure controls and monitoring to show variances between actual results and planned results?
• Are there units or divisions which require significantly more capital than others and earn lower returns on those investments?
• Have capital projects fallen short of the expected revenue growth or cost savings projected?
• Does your cost accounting system need to be updated for more timely cost and operating methods or overhead allocations?

3. Other Financial Characteristics

• Have receivables over 60 days increased over the past three months?
• Are receivables' increases the result of customer dissatisfaction (i.e., poor quality, shipping delays or returned product)? Have payables over 90 days increased over the past three months?
• Is the current ratio below standard industry norms and has working capital declined over the last three months? Are cash expenditures being delayed that could threaten survival or competitiveness?
• Are non-critical cash expenditures being made when cash conservation is called for?
• If business improves, will it be difficult to generate or borrow working capital to support the growth?
• Has the operation experienced inventory shrinkage problems over the past year?
• Has the company had trouble reducing inventory levels on sales declines?
• Is the company writing checks to vendors and then holding the checks for future mailing (held checks)?
• Manual checks exceed system-generated checks for any given month.

4. Constituency Characteristics

• Has your secured lender continued to raise concerns about deteriorating financial performance? Are phone calls and meetings with your banker becoming more frequent?
• Are suppliers becoming more difficult to deal with (i.e., are suppliers calling more frequently, or demanding payment or tightening terms)?
• Are customers becoming increasingly dissatisfied with your products, quality or service? Have any large customers been lost lately?
• Have bondholders, shareholders or directors voiced concerns about poor operating performance?
• Has the company had two or more different strategic plans over the past year?
• Is top management spending more time away from day-to-day operations and more time on financial matters (i.e., financing or asset disposition)?
• Have there been any recent problems related to union issues, government regulations or lawsuits?

5. Industry Characteristics

• Is your market or industry shrinking or consolidating?
• Has technology buying potential in your industry shifted away from the products to other competition?
• Is your market or industry impacted significantly by economic cycles or seasonal shifts?
• Are there a large number of competitors in your market or industry offering similar products or services with more competitive price/terms?
• Has foreign competition increased?

6. Management Characteristics

• Have the top managers expressed a need to improve teamwork?
• Have there been any significant changes in the Company "culture" in the past year?
• Has morale or turnover in top or middle management become a growing concern?
• Is there a need for better communications and focus throughout the company?
• Are plans, programs, budgets and accountability for their results made clear to managers?
• Is there labor unrest or evidence of labor problems such as absenteeism, increased workers compensation claims or poor productivity?
• Has there been a formal downsizing program initiated within the company in the past year?
• Is the company's infrastructure (i.e., systems, space, etc.) adequate to handle the present and near-term business levels?
• Has top management visited all key locations at least once in the last year?

If you feel that your organization has a present or potential problem, please contact LSH immediately for constructive thoughts and ideas on how to overcome company deterioration.

Lee, Sperling, Hisamune
550 North Brand Boulevard, Suite 525
Glendale, California 91203
Phone: (818) 507-6645 - Fax: (818) 507-7891
Email: lsh@leesperling.com