In any economic cycle, businesses across all industries experience periods of pressure. Sometimes it’s driven by market shifts, sometimes by cost volatility, and sometimes simply by operational growing pains. Rarely is financial stress a sudden event. More often, it unfolds gradually and quietly, through a series of small changes that only become obvious in hindsight.
Lenders review countless financial statements, forecasts, and operational updates every year. Over time, clear patterns emerge in businesses that begin to show signs of strain. These indicators are not meant to be alarm bells but rather serve as early signals. Understanding what banks look for allows you to tighten internal reporting, proactively communicate, and ultimately strengthen your credit profile. Below are themes banks often see in businesses facing emerging stress, and why they matter.
Many companies experience margin pressure due to rising labor, material, or overhead costs, but when gross or operating margins decline for several consecutive periods without a clear explanation, it raises concerns. This erosion often reflects deeper issues such as pricing that hasn’t kept pace with rising input costs, operational inefficiencies, or slow-moving demand. Lenders pay close attention to margins because they directly affect a company’s ability to generate cash and service debt.
Businesses that stay ahead of this trend typically have strong reporting by product, customer, or business line. They can clearly articulate what changed and what they’re doing about it, building lender confidence even in a challenging period.
One of the earliest signs of stress shows up in the working capital cycle, primarily through accounts receivable and inventory. When receivables begin aging out beyond normal historical patterns or payments slow down across key customers, it compresses liquidity. Similarly, when inventory builds faster than revenue or sits longer on shelves or in production, it ties up valuable cash.
These shifts matter because they reveal how effectively the company is converting revenue into cash. When working capital doesn’t turn, businesses become more reliant on their line of credit. Companies with tight AR oversight, frequent aging reviews, and solid forecasting generally navigate this challenge smoother.
Debt metrics are often the clearest indicators of rising credit risk because they show the intersection of operating performance and capital structure. Declining EBITDA combined with growing or static debt levels can quickly change a company’s leverage profile, compress flexibility and limit a company’s ability to absorb shocks.
It is common for EBITDA to fluctuate with market demand, pricing pressure, cost increases, or seasonal demand. However, sustained erosion is an early signal that the business may struggle to self-fund operations. A lender’s primary concern is whether EBITDA remains strong enough to support interest payments, scheduled principal amortization, capital expenditures, and working capital needs. When EBITDA shrinks, the cushion between cash flow and fixed obligations narrows, and the business loses the ability to absorb disruptions.
Leverage (Total Debt / EBITDA) rises for two main reasons: the numerator increases, the denominator decreases, or both. Growth capex, acquisitions, and draws on the revolver are normal activities, but can quickly drive leverage above historical levels. High leverage limits flexibility as it allows fewer options for additional financing, tightens loan terms, and covenant compliance becomes harder to maintain.
Coverage ratios – especially Debt Service Coverage and Fixed Charge Coverage – tell lenders whether a business produces enough cash to meet its recurring financial obligations. When these ratios approach covenant thresholds, it often reflects underlying operational challenges rather than just a temporary cash flow blip. A declining coverage ratio may indicate margins are shrinking faster than expenses are being reduced, interest expense has climbed (especially relevant after rate hikes) and working capital fluctuations are consuming more cash than expected. These ratios are crucial because they determine a lender’s comfort level with risk. They’re not just technical metrics, as they reflect the actual resilience of the business model.
Ultimately, lenders monitor these indicators not to be punitive, but to better understand the trajectory of the business and support management through periods of change. Companies that are able to provide the below tend to weather challenges more effectively.
Every business encounters headwinds. The differentiator is how early issues are identified and addressed. By recognizing the early warning signs of stress and taking proactive action, companies not only protect their banking relationships, but they build financial resilience that positions them for long-term stability and growth.