A company’s financial statements are the best way to analyze its health. It includes income statements, balance sheets, statements of retained earnings and cash flows. This report shows the revenue and expenses of the company over a particular timeframe, say in a financial year.
The financial report of a company not only displays its current state but also gives an insight to the company’s condition in future. Therefore, these statements should be analyzed carefully from time to time to catch problems before they turn into big headaches.
Today’s post throws light on those signals in financial statements that warn you against the future troubles related to the company’s finances. Here are 5 red flags you shouldn’t ignore in your financial statements.
The debt-to-equity ratio is used to measure the financial leverage of a company. It is calculated by dividing the total liabilities of a company by its shareholder’s equity. With this ratio, you can find out how much debt the company is using to finance its assets. If your company’s debt-to-equity ratio is rising over 100%, then it’s a warning sign that your business is absorbing more debt that its operations can handle.
Look at the revenue of three or more years. If you notice a declining trend, then something is terribly wrong. It indicates that your business is not in a good shape. Look into the matter by applying cost-cutting measures such as removing unnecessary expenses and improving inventory management.
Business expansion can lead to increased inventory. But, excess inventory without any income means that the products are not selling. If your products are perishable, then keeping them on the shelves or in the warehouse for a longer period can spoil them. A heightened inventory can be spotted by studying the balance sheet. Divide the ending inventory from the last year’s balance sheet by the sales of the current year. If you get a higher number, then its time to manage your inventory and sell your products accordingly.
Cash flow is an important part of a business as it shows the movement of money in or out of the business. The cash should be flowing in the business to ensure its smooth operation. However, if you have an abundance of cash, it means that your business is not getting new work whereas if you have a cash crunch, it means that you’re not charging the right amount for the work done by the company.
Other expenses are created to record small and inconsistent expenses in the income statement. However, if the amount recorded under the heading of other expenses show a significant increase, then its time to find out what’s the problem. Investigate what items are included in other expenses to figure out whether the company is spending money unnecessarily or not.
Go through the company’s financial statements carefully to understand whether your company is in good shape or not. If you find these red flags in the financial record, then look into the matter and fix the issue as soon as possible to save your business from trouble in the long run.
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