Let’s begin with looking at some obvious and easily recognizable red flags that should make you stop and rethink your decision of investing in the company.
- Over-attractive Financial Results
- Auditor’s Report to Management
When a company’s financial statements are audited, the auditor tracks all errors and includes the list under the section ‘Summary of Misstatements’ in the Auditor’s Report to Management. When you are looking at the financial statements of a company, this is an important section to look at. Sometimes, the management can have a different opinion compared to auditors. Hence, as a prospective investor, you must ensure that you compare the reports and identify any red flags.
- Unusual Accounting Policies
- Changes in Financial Reporting
- Anomalies in the Financials
- Complex Transactions
- Performance-linked Bonuses
- Gross Profit Margin Increasing but Sales are Declining
- Rising Debtors or Inventory
Remember, red flags are the potential threats that may lie buried deep within the financial statements of a company. While most investors are not chartered accountants or financial analysts, following the points mentioned above can help identify these red flags in financial statement analysis. This can ensure that you don’t make any investment decisions in haste.
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