---
name: distress-early-warning-signal-detector
description: "Evaluates a company's financial and operational metrics against a six-domain distress indicator framework — EBITDA margin trend, covenant headroom, cash conversion, customer concentration, working capital, and management stability — then assigns a composite risk rating with ranked priority flags and a monitoring cadence. Use when assessing portfolio company health, screening for early signs of financial distress, validating a board's confidence in management, or deciding whether a situation requires intervention."
argument-hint: "[company-financials] [period]"
allowed-tools: ["Read"]
---

# Distress Early Warning Signal Detector

## Purpose
Detect the early, leading signs of financial and operational distress in a company — before they show up as a covenant breach or a missed payroll — and convert scattered metrics into a single risk rating with ranked priority flags. Solves the problem of late-stage surprises: distress is almost always visible in the trend data months before it becomes a crisis.

## When to Use
Invoke this skill when the user asks to:
- Assess the financial health of a portfolio company or investment
- Screen for early warning signs of distress before a quarterly board meeting
- Decide whether a company needs intervention, a turnaround plan, or closer monitoring
- Validate whether management's narrative matches the underlying metrics
- Compare distress risk across multiple companies in a portfolio
- Build an ongoing watchlist of leading indicators to track

## Inputs Required
Before starting, collect:
- **Financials (3+ periods)**: Revenue, EBITDA, net income, and balance sheet for at least the trailing 3 quarters or 3 years
- **Debt structure & covenants**: Total debt, facility terms, and the specific financial covenants with their thresholds (e.g., max leverage, min fixed-charge coverage)
- **Cash position & conversion**: Current cash balance, free cash flow, and DSO/DPO/DIO if available
- **Customer concentration**: Revenue share of the top 1, 5, and 10 customers
- **Working capital detail**: Receivables, payables, and inventory trends
- **Management & organizational signals**: Recent C-suite/board turnover, key departures, or hiring freezes
- **Industry/context**: Sector, comparable margin benchmarks, and any known macro headwinds

If covenant thresholds or customer concentration are unavailable, score the domain on available proxies and flag it as a data gap that materially limits confidence.

## Instructions

### Step 1: Score the Six Distress Domains
For each domain, assign a status — **Green** (healthy), **Amber** (watch), or **Red** (distress signal) — based on the trend, not the absolute level. A declining trajectory in a healthy company is more predictive than a stable one in a stressed company.

**Domain 1 — EBITDA Margin Deterioration**
- Compare EBITDA margin across the last 3 periods.
- **Amber**: Margin down 100–300 bps over the trend window, or flat while revenue grows (operating deleverage)
- **Red**: Margin down 300+ bps, two consecutive periods of decline, or margin turning negative
- Distinguish structural decline (pricing/cost base) from one-time items — note which.

**Domain 2 — Covenant Headroom Erosion**
- Calculate current headroom against each covenant: (threshold − actual) / threshold.
- **Amber**: Headroom under 20% on any covenant, or headroom shrinking each period
- **Red**: Headroom under 10%, a projected breach within 2 quarters at current trajectory, or any actual breach/waiver in the trailing 12 months
- Model the next-quarter covenant position using the EBITDA trend, not the trailing figure.

**Domain 3 — Cash Conversion Decline**
- Calculate cash conversion: free cash flow / EBITDA (or operating cash flow / EBITDA).
- **Amber**: Conversion below 60%, or a 15+ point decline period-over-period
- **Red**: Conversion below 40%, negative free cash flow, or EBITDA growing while cash flow shrinks (an earnings-quality red flag)
- Earnings that don't convert to cash are the single most reliable distress predictor.

**Domain 4 — Customer Concentration Risk**
- Assess revenue dependence on the top customers.
- **Amber**: Top customer over 15% of revenue, or top 5 over 40%
- **Red**: Top customer over 25%, top 5 over 60%, or any sign of a key account at risk (contract expiry, reduced orders, payment delays)
- Concentration is a latent risk that becomes acute the moment one account wobbles.

**Domain 5 — Working Capital Deterioration**
- Track the cash conversion cycle (DSO + DIO − DPO) and its components over the trend window.
- **Amber**: Cycle lengthening 10–20%, DSO rising (collection slipping), or inventory building faster than sales
- **Red**: Cycle lengthening 20%+, DPO stretching sharply (a sign of stretching suppliers to manage cash), or a working capital drain consuming all operating cash flow
- Stretching payables while DSO rises is a classic liquidity-management distress pattern.

**Domain 6 — Management & Organizational Instability**
- Evaluate leadership and organizational signals.
- **Amber**: One C-suite or board departure in 12 months, a hiring freeze, or delayed/restated reporting
- **Red**: CFO or CEO departure (especially abrupt), multiple senior exits, auditor change, going-concern language, or a pattern of missed forecasts
- A CFO departing unexpectedly is one of the strongest qualitative distress signals there is.

### Step 2: Compute the Composite Risk Rating
Convert domain statuses to a portfolio-level rating:
- **Low Risk**: 0 Red, ≤1 Amber
- **Watch**: 0 Red, 2–3 Amber
- **Elevated**: 1 Red, or 4+ Amber
- **High Risk**: 2 Red
- **Critical**: 3+ Red, or any Red in Covenant Headroom combined with Red in Cash Conversion

Weight covenant headroom and cash conversion most heavily — these are the two domains where deterioration converts fastest into a liquidity event.

### Step 3: Rank the Priority Flags
List the distress signals in order of urgency, not domain order. For each flag:
- The specific metric and its current trajectory
- Why it matters (the mechanism by which it becomes a crisis)
- The likely time-to-impact (this quarter / 1–2 quarters / 6–12 months)
- The single most important follow-up question to ask management

### Step 4: Recommend Monitoring Cadence & Next Actions
Match intervention to the rating:
- **Low Risk / Watch**: Quarterly review; name the 1–2 metrics to track most closely
- **Elevated**: Monthly cash and covenant tracking; request a 13-week cash flow forecast
- **High Risk / Critical**: Weekly liquidity tracking; recommend convening the board, engaging a turnaround advisor, or opening lender dialogue before a covenant breach forces the conversation
- Always state the specific trigger that would escalate the rating.

## Output Format
- **Structure**: Executive summary with the composite rating up top, then a six-domain scorecard table, then ranked priority flags, then monitoring cadence and next actions
- **Length**: 800–1,100 words
- **Format**: Scorecard table for the six domains (Domain / Status / Key Metric / Trend / Note); prose for the summary, ranked bullets for flags
- **Sections**: Composite Risk Rating → Six-Domain Scorecard → Ranked Priority Flags → Monitoring Cadence & Next Actions → Data Gaps & Confidence
- **Tone**: Board-level and unhedged — the directness of a restructuring advisor who has seen distress arrive on schedule. State the rating plainly; do not bury the conclusion.

## Quality Checklist
Before delivering output, verify:
- [ ] All six domains are scored Green/Amber/Red with a stated metric and trend — none left blank
- [ ] The composite rating follows the stated scoring rules and reflects the domain statuses
- [ ] Priority flags are ranked by time-to-impact, not by domain order
- [ ] Each Red flag includes a specific follow-up question for management
- [ ] Monitoring cadence is matched to the rating, with an explicit escalation trigger
- [ ] Data gaps are named and their effect on confidence is stated — no false precision on missing inputs

## Notes
- Trend beats level: a company with healthy absolute margins that are declining sharply is more at risk than one with thin but stable margins.
- The two domains that convert fastest into a true crisis are covenant headroom and cash conversion — when both flash Red, treat it as Critical regardless of the other four.
- Qualitative signals (CFO departure, auditor change, restated reporting) often lead the financial signals by a quarter or two; weight them seriously even when the numbers still look acceptable.
- If management's narrative explicitly contradicts the metrics, flag the divergence — that gap is itself a distress signal.

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## How to use this skill

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**Using in Claude.ai, ChatGPT, Gemini, or other AI tools:**

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