How to spot business problems from your financial statements

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It is always preferable to anticipate and then to prevent problems in your business rather than having to deal with them when they occur. One way you can spot issues, over and above financial ones, is by paying attention to the information presented in your company’s financial statements.

There are six common signs or red flags that you can spot in your business’s financial statements that will tell you that, without suitable corrective action, problems are on the way.

1. Increrasing recivables

It might seem like a good thing that your business is owed money by customers or other parties. However, the receivables figure might look good on paper but there is in effect no money until it is collected and is paid into your account.

While it is not unusual to have outstanding amounts on a financial statement, warning bells should go off in your head if this figure is growing month on month. It is usually an indication that your credit policies or collections procedures need adjustment as they are clearly not working.

Furthermore, the longer money is due and unpaid, the more difficult you are likely to find it to collect it at all. This will have a severe negative impact on your profit levels and cashflow. It could also affect the credibility of your business.

2. Increased inventory 

An increase in inventory or stock volumes is easy to identify from your company’s balance sheet. There are two common reasons for an increase in inventory:

  • Your products are not selling: This is of course not a good sign, and the longer stock stays on the shelf the more you are exposed to risk. One way to protect yourself from loss is by ensuring you have adequate and appropriate business insurance. There are sites where you can compare policies and quickly obtain quotes and cover.

If the drop in sales cannot be attributed to broader issues such as economic downturn and you need to establish why sales are down and take urgent steps to boost them.

  • You have introduced a new product or line: This is a normal situation as shifting new stock can take a little longer than selling existing, known items. Having new products indicates that the company is growing but they need to be supported by suitable marketing and promotion so that they sell.

If you have more stock than in previous years, or a month over month increase, you need to pay attention and act.

3. Poor cash flow

All businesses require healthy and consistent cash flow. It is not enough that your business shows a profit on paper. Part of your income and profit need to be in your account as liquid or cash funds or you will struggle to pay expenses and meet extra expenses.

If you are not receiving payments that are due to you, you need to establish why. Are your credit or payment schedules, terms, or policies too lax? Do you have ineffective collections procedures that mean outstanding amounts are not followed up on? You or the responsible staff member needs to address these issues as a matter of urgency.

4. Fixed asset disposal 

It is common practise by most businesses to sell equipment that is either no longer being used, is outdated, or is not performing optimally. Where a problem can lie is in what is done with the funds raised by these sales.

The proceeds of asset disposal should not be used to settle or reduce debts or to cover the company’s short-terms costs. The funds should be utilised in such a way as to aid the future operating expenses. Similarly, losses due to disposal or write-offs of assets must be correctly recorded and allocated. A financial statement can highlight this too and an advisor can assist you if you are unsure or would like to check on the correct allocation of amounts.

5. High number of expenses allocated as “OTHER”

Other” is a commonly used allocation for a range of company expenses that do not fall under other items. However, these miscellaneous costs are ordinarily small. If you find that there are large amounts recorded as other they need to be investigated.

Larger amounts may be once-off expenses. In that case the allocation is acceptable. With others you may find that the amount should be reclassified and placed elsewhere. If however, these high amounts appear often or even regularly on your financial statements you need to re-examine matters further.

6. Non-operating income

While a healthy revenue or income that has been generated by the business’ ongoing operations is a good sign and something that investors look for, consistent non-operating incomes can be a warning sign. Examples of this type of income include the proceeds of the sale of investments or of fixed assets, or an unusually large single sale.

A business statement lists operational and non-operational income separately, which makes it easy for you to assess each. A steady rise of non-operational revenue should be a red flag that prompts you to examine both the sources and how to boost revenues from sales etc.

A business’s financial statements are not just for your accountant. They are crucial and valuable tools for you as the business owner. Examining them regularly will provide you with information and insights and help you to avoid problems and boost the efficiency and profitability of your enterprise.

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