Business accounts play a vital role in providing essential information about a business and offering insights into its prospects. That is, after all, the whole point of business accounting. Paying attention to certain red flags that may indicate potential issues within a company is crucial. You can look at the red flags we discuss as leading indicators of impending trouble. By identifying and addressing these red flags early on, businesses can avoid significant problems. Let’s explore the six most common red flags businesses should watch out for.
Increased Inventory Levels
It sounds good on the surface that you are increasing your inventory levels, but this may be a bad sign for many reasons. While expanding a product line often leads to increased inventory, stagnant sales alongside rising inventory levels may indicate slow-moving products. This raises the risk of obsolescence or spoilage, and businesses should take steps to accelerate the sale of these products. It’s also important to realise that the more inventory you hold, the more money you have tied up in inventory. If said inventory does not move satisfactorily, you are facing a cash flow crisis. Understanding why it is happening is always important, but this is an important red flag.
Growing Receivables
Sometimes to get clients, we have to offer credit to customers. Sometimes offering credit helps us expand our businesses. While a large accounts receivable figure might seem positive, it only holds value if those accounts can be collected. Delayed payments decrease the likelihood of receiving compensation. So having a huge balance of receivables is something to be wary of. Conducting an aged receivables report will usually pick this red flag up early. In such cases, businesses should consider refining their collections process and adopting stricter credit policies.
Decreasing rate of new business
The goal of any business should be to grow. The ideal situation is to have a strong base of existing customers while introducing new customers. This is a red flag if your business has a declining rate of new customers. It is hard to give a definitive figure for new customers, but your business history will tell you what makes sense and what is a red flag. Ideally, you want to keep this rate of new business steady or increasing; that is scaling.
Persistent Cash Flow Issues
Profitability on paper does not guarantee sufficient cash flow. Cash flow is a very important indicator of business health; if it falls on the wrong side, things can quickly fall apart. A consistent lack of cash inflow can raise concerns about poor collections, inflated revenue figures, or difficulties in loan repayments. Businesses should identify the root cause of the cash crunch, which could be a temporary situation or a result of inadequate collections efforts. Adjustments to payment schedules may be necessary. Just remember that cash flow problems are never caused but rather symptoms of a problem.
Reliance on Inconsistent Income
While consistent income from continuing operations is favourable, income from one-off events like the sale of fixed assets, one-time large sales, or investments is scepticism. On-going income is desirable, especially if we want the business to continue as a going concern. You will notice a shift in many global titans like Apple and Microsoft to offering services to generate more regular income, which has worked out very well for them. Focusing on solid and steady revenue sources is advisable to maintain investor confidence.
Significant “Other” Expenses
Many businesses have small or irregular “other” expenses, typically reflected in the balance sheet and income statement. However, abnormally high values for these expenses should be examined closely. It is generally a sign of poor expense tracking or assignment. Some expenses may need reclassification, while others could be one-time occurrences. Either way, if this red flag is not taken care of, these other expenses can pose a problem for your business in the long term.
Examining a business’s accounts provides valuable insights into its overall performance and prospects. By being aware of these red flags, businesses can identify and resolve issues efficiently before they escalate. This proactive approach helps businesses understand their profitability, liquidity, and cash flow, ensuring a healthier financial outlook.
