7 signs of a company in financial trouble

Declining liquidity ratio
The liquidity ratio indicates a company’s ability to pay off its current liabilities as they become due. A current ratio of less than 1 indicates a company’s short-term assets are not enough to meet current debt obligations.
Current ratio = Current assets / Current liabilities

Deteriorating net profit margin
Net profit margin measures how well a company manages its expenses relative to its net sales. Deteriorating net profit margins indicate that expenses are too high.
Net profit margin = Net income / net sales

Low free cash flow
Free cash flow tracks the cash a company has left over after meeting operating expenses. A company with negative free cash flow in a particular year indicates it was unable to generate sufficient cash to support the business.
Free cash flow = Operating cash flow – capital expenditure

Rising debt and declining profit margins
A company with more debt than assets are highly leveraged. The debt ratio analyses the overall debt burden of the company and its ability to pay it off in future. The net profit margins of such companies decline over the same period.

Sluggish inventory turnover
Inventory turnover measures the speed at which a company convert its inventory to sales. A low inventory turnover implies weak sales and excess inventory.
Inventory turnover ratio = Cost of goods sold /average inventory
Manipulation of financial statements
Some companies deliberately manipulate financial statements, showing improper revenues, liabilities, expenses and asset value. The Satyam Computer Services fraud in 2009 is a case in point.

Compromised quality A company compromising on quality after creating a brand over the years is a red flag. It ruins a company’s brand value, leading to drop in stock prices. Recent example is Welspun India.

Note: Stocks discussed are for illustrative purposes. No recommendations are given to buy or sell
Source: Capitaline, Compiled by ETIG