5 Red Flags in Your Financial Statements You Shouldn’t Ignore

Reading your company’s financial statements might not be the most thrilling task—but overlooking the numbers can cost you. Financial statements are more than just reports; they tell the story of your business's health, cash flow, and sustainability. And when something’s off, your balance sheet or income statement will usually be the first to show it.

Here are five common red flags in financial statements that business owners and managers should never ignore—plus why they matter.

1. Declining Gross Profit Margin

Your gross profit margin measures how much money your company retains after subtracting the cost of goods sold (COGS). If your revenue is stable (or even increasing) but your gross margin is shrinking, it could point to:

• Rising production or material costs

• Inefficient operations

• Pricing that's too low to maintain profitability

Why it matters: A declining gross margin means you’re earning less on each dollar of sales, putting pressure on cash flow and long-term viability. It can also signal competitive issues or poor cost control.

2. Rising Accounts Receivable (A/R) Without Revenue Growth

If your accounts receivable are growing faster than your revenue, that’s a warning sign. It suggests you’re selling more on credit—or having trouble collecting from customers.

What to look for:

• A high or increasing Days Sales Outstanding (DSO) ratio

• Customers exceeding payment terms or needing frequent reminders

Why it matters: Cash flow is the lifeblood of your business. Even if you're profitable on paper, cash stuck in receivables can make it hard to pay bills, invest, or meet payroll.

3. Negative Operating Cash Flow Despite Profits

Profit and cash flow are not the same. It’s entirely possible to show a profit on your income statement but have negative cash flow from operations.

This often happens when:

• You're investing heavily in inventory or A/R

• You're deferring expenses or recognizing revenue too early

• There's aggressive accounting involved

Why it matters: Profits without cash can mask deeper issues. Sustained negative operating cash flow can lead to insolvency—even if your income statement looks healthy.

4. Significant Changes in Liabilities

Watch for sharp increases in short-term liabilities (like accounts payable or short-term loans) that aren’t explained by corresponding growth in assets or operations. This could suggest:

• Over-reliance on debt to fund operations

• Delays in paying suppliers or creditors

• Cash flow pressures being temporarily covered by borrowing

Why it matters: A rising debt burden, especially without a clear growth strategy or repayment plan, can strain your balance sheet and scare off lenders and investors.

5. Inconsistent or Irregular Financial Trends

You should be able to spot consistent patterns in your financials—like seasonal trends or gradual growth. But if you notice erratic fluctuations in revenue, expenses, or margins without a clear explanation, that’s a concern.

Examples include:

• Sudden spikes or drops in revenue

• Large “miscellaneous” expenses

• Frequent restatements or corrections

Why it matters: Inconsistencies could be signs of accounting errors, lack of controls, or even fraud. They also make it difficult to forecast and plan effectively.

Final Thoughts

Your financial statements aren’t just for your accountant or the IRS—they’re vital tools for managing your business. These red flags don’t always mean something is wrong, but they do mean you should take a closer look.

Tip: Review your financials monthly, not just at year-end. If you spot one of these issues, don’t panic—but do consult with a qualified accountant or financial advisor to dig deeper.

Being proactive with your financial data isn’t just smart—it’s essential to building a resilient, profitable business.