Early Warning Signs of Business Failure: A Framework for Boards & Founders
Key Takeaways: Early Warning Signs of Business Distress
Financials Are Lagging Indicators: By the time trouble appears on the P&L or Balance Sheet, the decline has already begun. Effective turnaround requires monitoring operational "friction" rather than just financial fire.
The "Strategic Drift" Problem: 50% of SME failures are avoidable. They occur because leaders focus on their specific expertise (their "recipe") while ignoring 45 distinct warning signs in areas they don't watch.
The 6 Pillars of Prevention: The Early Warning Index™ (EWI) predicts insolvency risk by auditing six core areas:
Priorities: Is bad news traveling fast or being hidden?
P&L: Is the revenue forecast accurate or a "wish list"?
Position: Is strategy based on evidence or assumptions?
Pipeline: Are "zombie deals" inflating the sales outlook?
People: Is the team busy but producing unstable results?
Power: Will investors actually fund the next 6 months?
Actionable Insight: The EWI acts as a "smoke detector" for Boards and Founders, cutting through optimism bias to identify risk months before a crisis hits.
50% of business failures could be avoided with early intervention. If businesses had "smoke detectors", most leaders would remove the batteries because the alarms are annoying.
The Reality of Drift
I've spent 30 years as a Founder, Investor, and CEO. I've built companies, invested in businesses, and stepped in as CEO in others.
In every role, I noticed the same pattern. It wasn't that we were ignoring problems. We were focused on what we knew best. As leaders, we all have a "recipe." If you are a product founder, you look at features. If you are a sales CEO, you look at the pipeline. We rely on our experience to filter the noise and do the best we can.
But often, while we focus on the areas we know, or can see in front of us, minor issues in the areas we don't watch start to compound. By the time they appear in the monthly board report, the decline has already begun.
This slow drift is measurable long before it becomes dangerous if you know how and where to look.
From Recovery to Early Warning
A few years ago, I built the Recovery Odds Index™ to measure if a distressed business can be saved and how. It worked. People quickly started asking to modify it for prevention, as an early warning tool.
So, I built the Early Warning Index™ (EWI). It's a practical operating tool. It is a smoke detector. It catches the quiet deviations, the "kindling", before they turn into a blaze.
If your first warning sign comes from the P&L or the balance sheet, congratulations, you're already late.
EWI gives you signals much earlier than the numbers ever will.
The 6 Places Truth Hides (The EWI Framework)
We track 45 distinct data points to measure warning signs. We don't look for the fires; we look for the friction.
Healthy companies show consistency across these areas. Drifting companies don't.
1. Priorities (Leadership and Management)
The warning signs: In healthy companies, bad news travels fast. In crisis companies, bad news takes the stairs while good news takes the elevator.
The Metric: We track 11 leadership signals, but the most predictive is the quiet deviations. Does the Board ask hard questions? Do they avoid demotivating the founder? Does everyone work aligned on the right issues?
If your Board pack is filled with nothing but good news while the runway keeps getting shorter, it's time to realize that you're not really managing the company; you're just putting on a show. In high-functioning teams, participants address friction early on because they're all focusing on the same set of facts.
2. P&L (Financial Health)
The warning signs: Most companies treat cash like a strategic choice rather than a hard constraint.
The Metric: Beyond standard liquidity, we weigh Forecast Accuracy heavily. If your revenue forecasts are "rarely accurate" (a specific score in our model), you don't have a forecast; you have a wish list. Drifting companies often claim a short runway is a "strategic choice." It rarely is. It's usually a lack of options disguised as strategy.
A healthy financial team demonstrates consistent forecasting patterns and realistic planning.
3. Position (Product and Strategy)
The warning signs: The gap between what you think you sell and what customers actually buy.
The Metric: Of the 7 strategy markers we audit, the most dangerous is Product Evidence. Companies in decline rely on "assumptions only." Healthy companies show repeat customers and referrals. If your strategy is "interpreted differently across teams", you are simply burning cash to accelerate in a circle.
Successful companies base their strategy on customer behavior rather than relying on optimism.
4. Pipeline (Sales and Retention)
The warning signs: Optimism. I have never met a founder who wasn't optimistic about next quarter.
The Metric: The Index audits the whole funnel and specifically flags the "Zombie Pipeline", deals marked "closing soon" for 90+ days. If your churn is creeping into the 20-35 percent range, your bucket has a hole that no amount of marketing spend can fix.
Healthy pipelines exhibit predictable movement and maintain controlled churn.
5. People (Operations and Turnover)
The warning signs: Drifting companies are rarely lazy. They are exhausted. The hallmark of an early crisis is a sudden explosion of internal busyness.
The Metric: High turnover is a lagging indicator. We look for the leading indicator: Operational Bottlenecks. If your team is working 80-hour workweeks but delivery is "unstable or unpredictable", you don't have a resource problem; you have a process problem.
Healthy companies deliver consistently and execute predictably without causing burnout.
6. Power (Shareholder Relations)
The warning signs: Assuming the investors will be there when you need them.
The Metric: We assess Capital Availability across 3 dimensions, primarily Shareholder Trust. When trust drops, the checkbook closes long before the ask is made. We assess whether shareholders can and are willing to fund the next 6 to 12 months. Don't assume the answer is "yes." Ask.
Healthy companies maintain aligned expectations and have transparent capital plans.
Why SMEs Break
Most startups and SMEs are agile on paper but fragile in reality. They can pivot, but they lack the capital to absorb a long period of stagnation.
What is the difference between survival and collapse? It's how long the early warning signs go ignored. The advantage is that these indicators can be identified and acted upon well before they become costly.
The Takeaway
The Early Warning Index cuts through the optimism bias, the defensive storytelling, and the "everything is fine" updates. It gives Management, Boards, and Investors a shared language for risk and a way to act earlier with confidence.
You get a several-page report with emerging risks, short-term and long-term priorities, and a clear early warning map of where drift is likely to start.
Run the EWI once every quarter.
Founders: You get a clear map of where drift is starting before it becomes visible in the numbers.
Investors: Send this to your portfolio companies before their next quarterly update.
It's an easy-to-use tool that shows you exactly where the house is getting warm.
👉 Take the free test or see a sample report:
https://earlywarningindex.com
You get your top-level early warning score for free.
If you want the full 45-indicator report with risks and priorities, it's €199.