Which of the following are potential indicators of financial distress?
(i) A sudden drop in share price
(ii) Increased turnover
(iii) Increased gearing ratio
(iv)Fall in profits
A) All of them could indicate financial problems
B) None of these factors would cause much concern, especially in isolation
C) (i), (iii) and (iv) are bad news, but increased turnover would be good news
D) (i) and (iv) are indicators, but (ii) and (iii) are improvements to the financial position

Question

Quizplus · Accepted Answer

A sudden drop in share price reflects a fall in the overall value of the business. However similar organisations and general market conditions may have to be factored in before deciding that the company is in serious difficulty. Increased turnover might appear to be good news, but it will generally cause increased costs and the company could be at risk of "overtrading" which will cause cash flow problems if not managed carefully. Increased gearing indicates that the company has taken out a loan. Loans attract interest which has to be paid. The company must ensure that it is able to meet its interest obligations. More cash paid on interest means less for the shareholder. A fall in profits again means that less money is available for shareholders. However, a one-off incident might be identified. It is very difficult to make decisions based on one or two ratios. A lot more has to be considered!

Which of the Following Are Potential Indicators of Financial Distress