Article

Ilan Guedj, Saurav Karki, Tyler Radler, Kory Shipp

Businesses may exhibit warning signs of financial difficulty as early as three years before issuing an initial going-concern disclosure or seeking bankruptcy protection. For attorneys and financial practitioners, recognizing these signals can be advantageous for evaluating distress risk. Bates White colleagues Ilan Guedj, Saurav Karki, and Kory Shipp—and former colleague Tyler Radler—explore these signals in “Early Warning Signs of Financial Distress: Ratios, Going-Concern Disclosures and Sentiment” (part of the Financial Statements column).

The authors explore two approaches that offer early warnings. The first is standard financial metrics—such as liquidity, leverage, ability to service debt, and bankruptcy-risk models. Firms approaching a going-concern disclosure commonly experience deteriorating liquidity, greater leverage, lower Z-scores, and weaker debt-payment capacity. The second approach focuses on textual indicators from public disclosures—ex., negative messaging in MD&A discussions. For both, the authors illustrate practical tools to identify these trends, from financial ratios to modern text sentiment and regression analysis.

These methods cannot reliably predict bankruptcy. But they can help stakeholders flag issues that influence refinancing prospects, debt-covenant compliance, restructuring discussions, and required disclosures.  

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