When you look at financial statements, they’re not just rows of numbers—they’re stories about a company’s health and future. But sometimes, those stories include warning signs, or red flags, that hint something isn’t quite right. Recognizing these early can save investors, managers, and stakeholders from costly surprises. Let me walk you through some common financial statement red flags, how to spot them, and what to do when you see them.

One of the first things to watch out for is rising accounts receivable. This means a company is taking longer to collect money owed by customers. On the surface, it might not seem like a big deal, but if the amount keeps increasing, it could mean customers are struggling to pay or the company’s credit policies are too lenient. For example, imagine a retail business where accounts receivable jumps by 30% over a few months. That signals you might want to check if customers are delaying payments or if the company’s invoicing system is failing. The fix could be as simple as tightening credit terms or adopting software to automate collections[1].

Another glaring warning sign is when liabilities exceed assets. In simple terms, this means the company owes more than it owns, which can threaten its solvency. This situation is particularly concerning if it persists beyond expected seasonal fluctuations. For instance, a construction company might have higher liabilities in the winter due to slow project completion, which is normal. But if this imbalance continues through the busy season, it’s worth digging deeper to understand why. It could indicate overborrowing or poor asset management[1].

Moving beyond the balance sheet, the income statement offers its own red flags. One that jumps out is nonexistent or declining revenue. Imagine a startup whose sales dropped 20% year-over-year—this could mean products aren’t resonating with customers or the market is shrinking. Declining revenue often signals trouble ahead since the company may struggle to cover fixed costs. Additionally, watch for negative or falling profitability, like shrinking gross profits or operating income. If costs rise but revenues don’t keep pace, the business might be burning cash to stay afloat. Increasing costs without a clear business rationale, such as investments for growth, should raise eyebrows[3].

Sometimes, financial statements reveal more subtle issues. Frequent restatements, write-offs, or one-time expenses can be red flags, especially if they happen often. While these might be legitimate—for example, due to mergers or restructuring—repeated occurrences might suggest the company is masking ongoing problems. For example, a company repeatedly writing off large amounts of inventory could indicate poor inventory management or even fraud[3].

Watch closely for questionable accounting practices. Businesses under stress sometimes get creative with their numbers. This might include aggressive revenue recognition or related-party transactions where insiders do business with the company under favorable terms. For example, if the CEO’s family member wins lucrative contracts without competitive bidding, that’s a clear conflict of interest and a red flag. It’s crucial to check the footnotes of financial statements, where such related-party dealings are often disclosed. Lack of transparency here can be a major warning sign[2][4].

Another practical red flag is frequent or desperate loan requests. When a company repeatedly maxes out credit lines or urgently seeks new loans, it might be struggling with cash flow. If these loan requests lack detailed plans for repayment or use of funds, it raises questions about the company’s financial stability. For instance, a business that relies on personal credit cards to cover daily expenses is likely in trouble[4].

Inventory levels can also tell a story. Rising inventory alongside falling cash is a classic red flag. If a company is stockpiling products it can’t sell quickly, it ties up cash in assets that aren’t generating income. This scenario can strain working capital and may precede write-downs or losses. A sharp increase in inventory without a corresponding increase in sales demands an explanation—perhaps demand is dropping, or the company overestimated market needs[5].

To catch these red flags early, it’s essential to develop good habits. Regularly reviewing financial statements, not just at year-end, can help you spot trends before they become problems. Use ratios like the current ratio (current assets divided by current liabilities) to assess short-term financial health, or the days sales outstanding (DSO) to monitor how quickly receivables are collected. If you see the DSO creeping up steadily, it’s time to ask questions.

When you notice red flags, don’t panic. Instead, approach them as signals to dig deeper. Talk to management, ask for explanations, and compare financial statements over multiple periods. Sometimes, what looks like a red flag is just a temporary hiccup or part of a planned strategy. But if explanations don’t hold up or red flags multiply, it’s a sign to be cautious.

In my experience, the companies that weather financial storms best are those that face issues head-on rather than hiding them. Transparency with stakeholders and a willingness to adjust course are crucial. For investors or creditors, understanding these red flags can help you decide whether to continue your relationship, renegotiate terms, or exit entirely.

To put it simply: financial statements are like a report card, but sometimes the grades are hidden in the details. By learning to spot red flags like rising receivables, liabilities outpacing assets, declining revenues, questionable accounting, and cash flow problems, you can better protect your money and make smarter business decisions. Keep your eyes open, ask the right questions, and don’t be afraid to look beyond the numbers—your financial health depends on it.