Common Signs of Financial Distress for Co-ops

Common Signs of Financial Distress for Co-ops

  |  May 30, 2022

Adam Prescot

By Adam R. Prescot, Esq. | Shareholder, Bernstein Shur Sawyer & Nelson, P.A. | Portland, Maine

The cooperative business model promotes democracy and strives to facilitate much-needed fairness, equality, and justice in the marketplace. Co-op businesses also help bring new goods and services to market that might not otherwise exist in a community on a local, sustainable, and affordable level. But whether incorporated as a non-profit or for-profit entity, co-ops are, at their core, businesses that require a positive margin if they are to survive.

For a co-op to reach its economic, democratic, and social goals—including providing financial benefits to its members and other partners—the business must first achieve a solid and sustainable financial foundation from which work to attain those goals can flourish. In that regard, co-ops are similar to other types of businesses that rise and fall on financial performance. Yet, for a co-op, financial instability—or even failure—carries with it not only monetary loss to members, lenders, creditors, and others in the community. Poor financial performance also results in the lost opportunity to achieve those democratic ideals and improve the community.

The definition of financial distress can vary by business and industry, but generally speaking, financial distress exists when a company cannot generate sufficient revenue to pay its expenses as they come due. Businesses of all types encounter financial distress through many different factors such as rising supply costs, increased overhead, changing consumer demand, or inadequate capitalization. In some cases, those financial problems are even created at the time of the co-op’s formation, including by taking on far too much debt than the business can reasonably service given its revenue and expenses. However, as a professional in the field of business reorganizations, I have observed one commonality among financially struggling businesses that stands out from the rest: the inability to recognize the financial danger until it is too late to fix.

Here are four warning signs that every co-op board and management team should watch for to ensure that financial risks are recognized early and necessary changes are implemented quickly, allowing your co-op to achieve its goals:

Decreasing Revenue

Warning Sign #1: Decreasing Revenue, Margin, and Negative Financial Trends

One common warning sign is a negative trend in financial performance. Different businesses focus on different metrics to evaluate their financial health, but indicators such as declining sales, shrinking margins, and year-over-year operating losses should be a flashing red light to any co-op. Early on, each co-op should establish which financial metrics are most important to its business model.

Distinguishing between a temporary downturn and a long-term problem also has been especially hard over the past two years, due to the impact of the COVID-19 pandemic. However, to recognize these problems and stay on top of the financial situation, it is critical to establish accurate and timely financial reporting (including on a daily, weekly, and monthly basis), to prepare and regularly revisit detailed budgets, and to hold frequent meetings with the business’s core financial team. Early vigilance and action are critical to adapting and implementing solutions.

Paying Vendors

Warning Sign #2: Defaulting or Slow Paying with Vendors

Many co-ops rely on vendors to provide critical goods and services to sustain the business. Often those vendors provide payment terms through short extensions of credit, such as “NET–7” or “NET–30,” which allow the co-op to manage cash flow and pay invoices after it has realized the revenue related to that product. However, if the co-op finds itself missing payment deadlines or asking for extended credit terms from vendors, that often is an early sign of financial trouble and cash flow difficulties. These problems can be due to business seasonality, competing cash needs, or a host of other reasons. It also can be difficult to climb out of that situation, straining critical vendor relationships and leading to a downward “snowball” effect on the co-op’s overall financial health.

To avoid this situation, the business should maintain up-to-date accounts payable records so the business knows exactly what is due, when, and for how much. If the company begins seeing its payables stretching days or weeks late on a regular basis, it should be proactive to identify the causes of the delays and to work with the vendors on accommodations to become current again.

Cash Shortage

Warning Sign # 3: Frequent Cash Shortages

Cash shortages are related to the other warning signs. If the co-op finds itself in a daily or weekly cash crunch—whether that is cash for vendor payments or debt service or payroll—that usually is a sign of an unhealthy financial situation and an unhealthy business. These emergencies also may strain relationships with critical partners and lead to borrowing more money at high-interest rates, adding to the “snowball” effect.

Cash shortages can occur on the revenue or expense side (or both), such as through loss of a major customer, higher supply costs, rising labor costs, or even simply the seasonality of the business. Once again, detailed budgeting to project future revenue and cost challenges is critical, as well as frequent monitoring of the cash situation to anticipate and address shortfalls before they arise.

Capital Improvements

Warning Sign #4: Deferred Maintenance and Capital Improvements

Maintenance and capital improvement needs will vary widely, based on a co-op’s business. However, for any business to run at peak efficiency and put its best foot forward in the market, it must maintain its assets and regularly invest in capital improvements. The deferral of these investments, on the other hand, can result in deteriorating assets, lost enterprise value, a negative public perception, and an overall inefficient business.

Co-ops should identify their capital improvement needs and develop a short- and long-term plan to fund those expenses. At the same time, the company should develop a plan to fund both necessary and desired projects, whether through selling assets, taking on new debt, or raising new equity.

Conclusion

The cooperative business structure plays a vital part in the American economy. When a co-op thrives, its members, vendors, customers, lenders, and entire community benefit. However, those benefits are only realized when the co-op is financially healthy and can achieve its economic and non-economic goals.

Because you cannot solve a problem until you recognize that it exists, staying vigilant for signs of financial trouble will ensure that the maximum range of options is available for a co-op to make necessary changes and to get back on track to achieving its goals.

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