Your company’s financial reports provide important clues about the monetary health of your business. Some of these clues manifest as financial warning signs. Becoming more familiar with your company’s financial statements not only helps you recognize many red flags, it lets you use them to make decisions that will divert trouble down the road. Here are 5 common financial warning signs to watch out for.
1. Poor Cash Flow Habits
Is your business profit-rich, but cash-poor? If your financial statements show you’re turning a profit but your bank account indicates otherwise, it might be time to take a closer look at your cash flow. Where is all that revenue on paper actually going?
Some of the most widespread business cash drains include:
- unmanageable overhead expenses,
- unsustainable debt loads, and
- uncollected accounts receivable
Some cash flow issues are temporary and are related to seasonal slowdowns or other external factors. Budgeting ahead and learning to adjust your cash outlay during these times can be helpful. But when income is consistently up and cash on hand is down, it can herald a cash crunch to come. Locating the cause and taking steps to correct it is crucial for long-term success.
2. Receivables That Consistently Climb
A balance sheet that’s heavy on the accounts receivable is a double-edged sword. On the one hand, it shows sales are thriving. On the other, it’s an indicator that a large portion of your company’s profits are tied up in unpaid customer invoices.
When you have an accounts receivable balance that consistently climbs, it usually means one (or more) of the following:
- Your customer base, number of sales, or average sale value is growing
- Your credit policies are too lax
- Your business isn’t efficiently collecting money owing from clients
It’s important to figure out which of these situations applies to your business. The biggest problem with letting receivables get out of control is that they don’t truly become revenue until payment has been received. The longer your receivables remain uncollected, the greater the likelihood they’ll become uncollectible and will have to be written off as bad debt.
3. Too Many Miscellaneous Expenses
The money flowing out of your business as expenses should be scrutinized carefully, regularly, and in conjunction with the money flowing in as revenue. It’s not uncommon for companies to have small, one-time, or non-operating costs that get lumped together as Other Expenses on their income statements, including:
- income tax expenses,
- interest paid on loans, and
- appreciation or amortization amounts
But you should watch for miscellaneous expense balances that are constantly elevated.
Large, unclassified expenses make it challenging to properly monitor where your money is going and can be a sign that you’re spending too much on items unrelated to the running of your business. Consider seeking advice from an accounting professional to recategorize some of these expenses.
4. Rising Inventory Levels
Not every business carries inventory. But for any that do, it’s important to recognize that the more money you have tied up in goods, the less cash you have on hand to deal with debt obligations or unexpected expenses.
Inventory levels that consistently rise on your balance sheet should be examined for:
- a corresponding increase in product offerings,
- products that aren’t selling, and
- items that have become obsolete or damaged
A good rule of thumb when investigating your inventory load is to monitor your inventory turnover. One way to accomplish this is by dividing last year’s ending inventory value by this year’s sales figure. If the result is higher than usual, it either means you’re selling less of something or that you’re keeping more inventory than usual on hand.
5. Income Sourced from Non-Operations
All income is not created equal when it comes to assessing the health of your business. The money you earn from sales and other business operations should be the primary source of income on your income statement. It should also be sufficient to fund your short-term, operational expenses. Dig deeper if the proceeds your business realizes from selling fixed assets or long-term investments have been pushing your non-operating income up year over year. It’s important to ensure that your business hasn’t been inadvertently relying on such income to support its daily spending.
Financial statements provide valuable insight into the liquidity, profitability, and performance of your business, both today and tomorrow. By heeding potential warning signs as they appear, you’ll be better equipped to make the right decisions for your company and avoid the money woes that put many ventures out of business.