13
RIMJHIM DUBEY
RED
FLAGS
TO LOOK FOR IN
FINANCIAL
STATEMENTS
INCONSISTENT REVENUE OR
EXPENSES
• Sudden and unexplained fluctuations without
clear explanation.
• Lack of alignment with market trends or
business operations.
Example:
A company shows a sudden spike in revenue
without entering new markets or launching new
products.
RIMJHIM DUBEY #1
BIG CHANGES IN ACCOUNTING
POLICIES & ESTIMATES
• Regular or unjustified shifts in accounting
practices.
• Changes that improve financial appearance
without operational justification.
Example:
A company changes its revenue recognition
policy from cautious to aggressive without any
industry or internal business changes to support
the shift.
RIMJHIM DUBEY #2
MAJOR CHANGES IN FINANCIAL
RATIOS
• Unusual changes in liquidity, profitability, or
solvency ratios.
• Ratios not aligning with industry benchmarks or
trends.
Example:
A significant shift in the debt-to-equity ratio with
no new financing or debt reduction.
RIMJHIM DUBEY #3
WEAK CORPORATE GOVERNANCE
• Absence of clarity in financial disclosures.
• Ineffective internal controls or oversight
mechanisms.
Example:
A company repeatedly fails to provide detailed
explanations for reserve changes or asset
valuations.
RIMJHIM DUBEY #4
POTENTIAL LIABILITIES AND
OBLIGATIONS
• Hidden or potential legal actions.
• Substantial off-balance-sheet liabilities or
unexplained .
• Rises in contingent liabilities.
Example:
A sudden rise in operating lease commitments,
purchase commitments or contingent liabilities.
RIMJHIM DUBEY #5
TRANSACTION WITHOUT
EXPLANATION
• Transactions without clear business justification
or proper documentation.
•Large, uncommon, or singular items without
sufficient explanation.
Example:
Significant payments to a newly formed company
without clear service or product delivery.
RIMJHIM DUBEY #6
DECREASING PROFITABILITY
• Steady decline in margins without market or
operational causes.
• Profitability trends not matching changes in
revenue or business activity.
Example:
Continuous decline in net profit margin while
revenues remain stable.
RIMJHIM DUBEY #7
RISING DEBT LEVELS
• Sudden surge in borrowing without
corresponding investment in growth or
operations.
• Debt levels climbing faster than industry
standards or company revenues.
Example:
Sharp rise in long-term debt with no
corresponding expansion in facilities or
operations.
RIMJHIM DUBEY #8
NEGATIVE CASHFLOWS
• Continual outflow of cash from operating
activities.
• Cash flows insufficient to back business
expansion or investment ventures.
Example:
Consistent negative operating cash flow while
reporting profitability.
RIMJHIM DUBEY #9
HIGH DEFAULT OR BAD DEBT RATES
• Unexpected surge in borrowing without
corresponding investment in growth or
operations.
• Debt levels escalating beyond industry
standards or company revenues.
Example:
Sharp rise in long-term debt with no
corresponding expansion in facilities or
operations.
RIMJHIM DUBEY #10
INCONSISTENT NUMBERS
• Discrepancies or illogical connections within
financial statements.
• Frequent revisions or restatements of
previously declared figures.
Example:
Discrepancies between cash flow statements and
income statements not explained by non-cash
adjustments.
RIMJHIM DUBEY #11
UNUSUAL ACCOUNTING PRACTICES
• Adoption of unconventional accounting
methods uncommon in the industry.
• Practices that manipulate income or expenses
to change financial presentation.
Example:
Changing depreciation methods abruptly to
enhance earnings without operational
justification.
RIMJHIM DUBEY #12
ACCUMULATION OF INVENTORY
• Excessive growth in inventory levels relative to
sales expansion.
• Inventory obsolescence or slow turnover,
suggesting possible overproduction or waning
demand.
Example:
Inventory doubled, sales rose 10%, indicating
possible demand or management issues.
RIMJHIM DUBEY #13
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