How to assess a companys risk of financial distress before it becomes critical

Intro

Financial distress rarely starts as a single event. It shows up as a pattern across liquidity, cash conversion, leverage, and decision speed. This page is a practical checklist you can run monthly.

1. Monitor financial ratios

Track these three first. They move before the P and L does.

  • Liquidity ratio: ability to cover short term obligations

  • Net debt to EBITDA: leverage and covenant pressure

  • Interest coverage: ability to service debt from operations

If one ratio trends the wrong way for two periods, treat it as a signal, not noise.

2. Analyze cash flow

Look past profit and focus on cash behavior.

  • Operating cash flow vs net income: gap means earnings quality risk

  • Cash conversion cycle: days tied up in inventory and receivables

  • Collections: overdue buckets and customer concentration

If the cash conversion cycle is lengthening, distress risk is rising.

3. Evaluate debt levels and covenants

List all debt, maturity dates, and covenant tests.

  • Headroom today: current position vs covenant threshold

  • Sensitivity: what one bad quarter does to headroom

  • Breach horizon: how many months until breach at current trend

Control often shifts at breach, not at zero cash.

4. Use a simple predictive model

Use one model as a cross check, not as truth.

Altman Z score or similar: good for trend direction

Use the model output as a prompt to inspect ratios and cash again.

5. Assess governance and decision latency

Distress accelerates when decisions slow down.

  • Are owners and board aligned on reality

  • Are hard decisions made fast

  • Is reporting trusted and timely

If decision cycles stretch, operational fixes arrive too late.

6. Monitor external signals

Watch what the outside world sees.

  • Credit score changes

  • More supplier prepayments or tightened terms

  • More lender requests for reporting

  • More customer churn or delayed renewals

These shifts usually arrive after internal signals, so treat them as confirmation.

Call to action

If you want a structured way to spot the early signals across leadership, governance, execution, and finance, run the Early Warning Index assessment.

Take the Early Warning Index assessment and see where your stand and how to get ahead.