Financial data provides important information about businesses. In addition to financial terms, it gives insight into the company’s future. From time to time, issues may arise. However, if they are discovered early, they will prevent a major headache in the future. Below are six of the most common red flags that may indicate potential problems.
Increasing Inventory
It’s common for companies to expand their product lines, resulting in increased inventory. However, if inventory is rising but there are no changes in the company’s offerings, it may mean that products are not selling. In many industries, the longer a product sits on the shelf, the greater the risk of it becoming obsolete or damaged.
This problem can be easily seen by examining the financial statement. It is important to calculate the current year’s inventory using the ending inventory figure from the previous year’s financial statement. This amount is divided by the current year’s sales. If the number is larger than in previous years, action should be taken to move products at a faster pace.
Increasing Accounts Receivable
While a large accounts receivable figure might seem good, it is only profitable if collected. In the business world, the longer an account remains unpaid, the more likely the company is to not be compensated. When accounts receivable start to increase, it may be necessary to adjust the collection process and become stricter with your credit policies.
Disposing of Fixed Assets
It is acceptable to sell old equipment that is no longer in use or is no longer functioning effectively. However, the proceeds from the sale should not be used to pay off debts or cover short-term expenses. When this occurs, it may cause problems for the company’s future expenses. To ensure profits, losses, and disposals are being used correctly, it is wise to review the income statement and the financial position statement.
Bad Patterns in Cash Flow
Even if the company shows a profit on paper, it may be cash flow constrained. When cash is not flowing into the company, investors may start to worry about improper accounts collection, inflated revenue, or difficulties in repaying loans. If net cash flow is consistently low, you may face a cash crisis. When this happens, it is essential to identify the cause. Often, it may be due to a slow month or similar circumstances. However, if the cause is due to poor collection efforts, it is advisable to communicate with your customers and push for payment.
After identifying the root of the crisis, you will have a better understanding of when cash will flow best. This may mean that you need to adjust your payment schedule.
Non-Operating Income
It always looks good when your company shows consistent income from ongoing operations. Investors often feel concerned when they see income from the sale of fixed assets, one-time large sales, or investment sales. Operating income is listed separately from non-operating income on your income statement. If you notice a significant increase from year to year, it may be necessary to target sources of revenue that are stable and consistent.
High Amount of “Other” Expenses
Many companies have small or irregular “other” expenses. This is normal and is reflected in the financial statement and income statement. However, when these items have high values, they represent a red flag and need to be investigated. In many cases, some of these expenses can be reclassified. In other instances, a high value may be due to a one-time event.
Diving deeper
In your company’s financial data, you will gain significant insight into its overall performance and future. Understanding the key red flags will help you identify problems and resolve them efficiently before they become major issues. This way, you will have a true understanding of your business’s profitability, liquidity, and cash flow.
Source: https://www.thebalancemoney.com/red-flags-in-your-financial-statements-3958554
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