Warning Signals in Financial Statements

This is by no means an exhaustive list, but any one of the signals could mean there is a problem. The more warning signals there are, the higher the risk.

Directors’ Report / Auditor Report

  1. Any disclosure indicating serious financial or other difficulties?
  2. Accounts not fairly presented or liquidity problem?
  3. Accounts qualified or any matters of emphasis in the audit report?
  4. Risks identified in management discussion and analysis?

Balance Sheet

  1. Are other debtors large in relation to trade debtors and what are other debtors?
  2. Any evidence of significant deferred expenses and is the deferral period sensible?
  3. Any capitalisation of expenses?
  4. Is useful life of fixed assets being extended?
  5. Is property being devalued or re-valued upwards?
  6. Has profit been achieved largely by the change in one provision?

Income Statement

  1. Is operating profit low, falling or is there a loss?
  2. Is profit volatile?
  3. Has change in accounting policy been responsible for improving reported profit or minimising loss?
  4. Do “unusual” items recur?
  5. Are significant abnormal gains offsetting abnormal losses?

Cash Flow Statement

  1. Are receipts from customers lower than payments to suppliers and employees?
  2. Is the net cash flow from operating activities negative or relatively small?
  3. Is positive cash flow largely the result of non-operating items?
  4. Is the operating cash flow above/ lower than the operating profit after tax (NOPAT)?
  5. Has there been a significant acquisition where goodwill [or other intangible assets] represented a large portion of the price?


  1. Any evidence of losses kept off-balance sheet?
  2. Any unconsolidated, controlled entities in the group?
  3. Any evidence of involvement (whether on or off balance sheet) in special purpose entities?
  4. Significance of non-controlling interests; impact on profits and cash flows available to parent shareholders?
  5. Any significant shareholdings which are not appropriately treated? E.g. methods of accounting for interests in associates, joint ventures, unquoted investments.
  6. Any acquisition or disposal related activity in the period? Consider the potential impact of such activity on results, balances and cash flows when reviewing financial ratios.

Notes to the Accounts

  1. Review the section on critical accounting estimates and management judgements, what issues do they raise, are there any issues which, given the industry, you would expect to see discussed which are not?
  2. Are there contingent liabilities, which might indicate large risk – guarantees to 3rd parties, legal disputes?
  3. Are there related party transactions, which could result in losses?
  4. Are there exposures to financial derivative transactions which could cause significant losses? Note some entities may discuss such risks in the management discussion and analysis section before the financial statements.
  5. Are there any voluntary or required changes in accounting policies that have positively impacted earnings or net assets?
  6. Is the income recognition policy appropriate?
  7. Have there been any restatements due to errors in accounts in previous periods?


  1. Is current ratio declining?
  2. Is current ratio/quick ratio/cash ratio low?
  3. Is company generating cash?
  4. Are debtor days rising?
  5. Are inventory ratios rising & profitability ratios declining?
  6. Is gearing high?
  7. Is debt funding not linked to assets being financed?
  8. Is more than one of the profitability ratios declining?
  9. Has the above been present over a number of years?
  10. Do profitability ratios appear satisfactory but cash flow profitability ratios don’t?

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