How to Detect Business Bankruptcy: Hancock Fabrics Case Study
As any savvy shopper knows, a good seamstress or tailor can work wonders with even a basic pattern. But while an expert can make a poor fit better if the starting point is good, sometimes the problem is beyond repair.
Business isn’t so different. When key financial numbers don’t line up, the right combination of strategy and management can sometimes alter the company’s course. But when problems persist quarter after quarter, bankruptcy is likely. To recognize the early warning signs, you simply need to know how to read the patterns.
Financial Distress in Retail
Hancock Fabrics, a retailer that offered fashion and home decorating textiles, sewing accessories, needlecraft supplies, and sewing machines, filed for bankruptcy in February 2016. At the time, the company operated 263 stores in 37 states, plus an Internet store. Yet to the trained eye, bankruptcy came as no surprise.
Like other retailers, Hancock faced an uphill battle. As this McKinsey report explains, many brick and mortar retailers struggle to compete with online shopping. Now that “the world’s largest store [is] in every pocket,” specialty retailers such as Radio Shack, Sports Authority and Hancock Fabrics have closed their doors. Retail bankruptcy risk was +128% compared to before the last financial crisis, at the time of Hancock Fabrics’ failure.
Early Signs of Business Bankruptcy
Every company has some exposure to financially stressed customers or suppliers. Yet many financial professionals still rely on misleading data to evaluate financial stress and the creditworthiness of public company customers and suppliers.
Accepted wisdom would have you track payment history, but research shows that’s unreliable. Public companies tend to make consistent payments right up to the point of business bankruptcy. And other common indicators only tell part of the story. For instance, the Altman Z”-score failed to predict Hancock’s fall, and the DBT Index barely budged.
But if you’d been looking at these critical signs, you would have seen trouble coming:
- FRISK® score in free fall, deeper in the “red zone”
- Market capitalization down 97% in just one year, a major red flag
- Operating margins and free cash flow consistently in the red
Hancock Fabrics displayed them all, plus more.
Hancock’s impending bankruptcy was clear to those who knew how to read the patterns. Still, keeping up with a barrage of new information as financial conditions deteriorate is a challenge.
Sometimes events leading up to a bankruptcy unfold slowly, while other times financial deterioration is more rapid, unraveling in a matter of months. Hancock had been struggling for years, but serious distress became even more apparent when the FRISK® score fell to a “2” – well below its industry average and its own 11-month average – in November of 2015.
From a business standpoint, you need a timely warning of risk that is not too early, and not too late, to maximize sales while preventing loss. But, when your customer can no longer generate enough cash from operations and liquidity suffers, it’s time to act.
By using the right tools and processes, you can detect increasing financial stress and manage your financial risks in time to prevent loss.
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