Chapter 11 Warning Signs: What the Client’s CPA Sees First

Financial Reporting | October 26, 2026

Chapter 11 Warning Signs: What the Client’s CPA Sees First

The client's CPA often sees financial distress in the records months before a lender acts. A short early warning system turns those observations into decisions while the company still has options.

Carlos Flores

Commercial Chapter 11 filings rose 11% to 6,560 in the first nine months of 2026, and Subchapter V elections, the small-business track, rose 46% to 2,442, according to Epiq AACER and the American Bankruptcy Institute. Warning signs typically show in the financials well before creditors take protective action.

The client’s CPA is often the first professional to see them. The CPA works with the bank statements, the payroll tax filings and the vendor and loan statements, and for some clients sees the lender’s compliance certificate. Management tends to read the same signs as temporary, because the most important ones appear while the company still looks healthy.

The going-concern guidance lists related conditions among its examples: recurring operating losses, default on loans and the denial of usual trade credit from suppliers (ASC 205-40-55-2). The practical question is what to do with them while options remain.

Four signals in the client’s records

Four signals tend to appear in the client’s records months before a filing. None of them needs clean books, and most show up in documents the CPA already holds.

SignalWhere the CPA sees itWhat it indicates
Late or partial payroll tax depositsDeposit records, IRS notices, payroll reconciliationsWithheld taxes are being used as working capital
Stretched payablesPayables aging, vendor statements, credit holds, cash-in-advance demandsSuppliers are financing the company
Merchant cash advancesBank statements: a large deposit, then fixed daily or weekly debits to a funder; new UCC filingsCostly short-term cash; repeat advances suggest operations cannot repay them
Repeated covenant waiversCompliance certificates, loan amendments, more frequent lender reportingLess room in each new negotiation with the lender

The bank data is a signal in its own right. In a study of bank borrowers, credit line usage, limit violations and cash inflows showed abnormal patterns about 12 months before default.

A three-step early warning system

Turning a signal into a decision takes three things: readings that can be trusted, a short list of numbers with thresholds set in advance, and alert levels that tie each reading to an action. The CPA can help management set up all three; management owns the thresholds and the decisions. For attest clients these are nonattest services, so management also designates an individual with suitable skill, knowledge and experience to oversee them.

Step 1: Readings that can be trusted

Weak books limit which readings can be trusted; they do not rule out the system. If the books are reconciled and closed within 30 days of month-end, every metric in Step 2 works. If they are not, metrics 3 to 6 still work: past-due payments come from vendor, loan and card statements, and the 13-week cash forecast from bank and card statements and tax deposit records, while the books are fixed in parallel. The CPA is usually best placed to say which case applies.

The 13-week cash forecast is the core instrument at every level of book quality. It is updated weekly against actual results, in a base and a downside case, and shows when each obligation falls due, including payroll taxes, rent and automatic card payments.

Step 2: A short set of tracked metrics

What matters is choosing the right indicators, not tracking many. Six are enough, each with a threshold agreed in advance:

MetricThresholdClean books needed?
1. Operating profit trendLast 12 months below the prior yearYes
2. Days to collect and days of inventoryAbove last year and the industry median two months runningYes
3. Payments past dueSuppliers over 15 days late two months in a row; any loan or card payment 30+ days past dueNo
4. Debt payments coveredCash and unused credit below 1.2 times the debt payments due in the next six months, or a credit line over 90% drawnNo
5. Weeks of cashUnder 13 weeks, from the 13-week cash forecastNo
6. Forecast varianceOver the last four weeks, collections below 90% or spending above 110% of forecastNo
Step 3: Alert levels set in advance

Five levels, agreed in advance with the CEO and the board, tie each reading to a response:

LevelTriggered byResponse
5. NormalBooks current; all six metrics inside thresholdsMonthly review within 30 days of month-end
4. WatchBooks late or unreliable; metric 1 or 2 beyond threshold; loss of a key customerFind the operating cause; fix the books
3. AlertUnder 13 weeks of cash on the downside case; metric 3, 4 or 6 beyond thresholdWeekly cash meeting; freeze discretionary spending and hiring; contact lenders before any breach
2. DangerUnder 13 weeks of cash on the base case; coverage below 1.0; a loan payment 90 days past due; a supplier credit hold, loan breach or judgmentDaily cash control; out-of-court and Chapter 11 options prepared; restructuring counsel retained
1. CriticalUnder 4 weeks of cash; payroll or payroll taxes unfunded; a levy on the operating account; a forbearance with a sale or filing dateFiling or sale options ready with counsel

Because the tests are set in advance, management does not grade itself, and the CPA reports a reading rather than a verdict. At Levels 3 to 1, the CPA documents each reading, and at Level 2 recommends restructuring counsel in writing. The company moves to a less severe level one step at a time, only after the trigger has been fixed and has stayed clear for three months. A promised fix does not count; a signed waiver, paid arrears or closed funding does.

When to bring in restructuring counsel

At Level 2 (Danger) at the latest. The company is close to default, and each week narrows the options in and out of court. Lenders often offer forbearance before enforcing a breach; its milestones set the company’s timetable. Counsel engaged before those milestones are written has more to work with.

Until counsel is engaged, three steps keep the position from getting worse:

  • Keep payroll tax deposits current. Unpaid withheld taxes can become a personal liability for the individuals responsible for paying them; raise any gap with management in writing.
  • Avoid new merchant cash advances. A new advance at Level 2 or 1 adds daily debits to a company already short of cash.
  • Have the financial data ready. A case moves faster when the bank statements, tax returns, receivable and payable agings, and loan documents are already assembled; The Chapter 11 Pre-Filing Data Package sets out what that package contains.

Counsel advises on whether and when to file, and on the options short of filing.

An early warning system will not prevent every filing. It buys what most distressed companies run out of: time to choose. The CPA, who sees the records first, is often the professional best placed to raise the first flag.

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Carlos Flores is a turnaround manager and fractional CFO with CFO Fractional. He serves as financial advisor to the debtor or chief restructuring officer in small and mid-sized Chapter 11 cases.

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