Financial Statement Red Flags
Financial statements don’t fail loudly — they whisper warnings long before trouble becomes obvious. The goal isn’t to find perfection, but to identify patterns that signal rising risk.
A single red flag rarely matters. Multiple red flags across statements usually do.
Income Statement
- Revenue Growth < 10% YoY — Slowing top-line momentum
- Gross Margin < 10% — Weak pricing power (industry dependent)
- One-Time Income > 15% of Net Income — Earnings quality risk
- Operating Margin < 15% — Inefficient core operations
- Interest Coverage < 2x — Earnings barely covering debt costs
- SG&A > 30% of Revenue — Overhead growing faster than sales
- Interest Expense > 20% of EBIT — Debt burden rising
- Falling EPS Trend — Profitability eroding over time
- ROE < 5% or ROA < 3% — Poor capital efficiency
Balance Sheet
- Current Ratio < 1.0 — Short-term liquidity stress
- Quick Ratio < 0.8 — Limited liquid assets
- Debt-to-Equity > 2.0 — Excessive leverage
- Declining Cash Reserves — Shrinking financial buffer
- Negative Working Capital — Liabilities exceed near-term assets
- Inventory Turnover < 2x — Slow-moving inventory (industry dependent)
- Receivables Days > 60 — Collection risk rising
- Declining Book Value per Share — Shareholder value erosion
- Declining Tangible Net Worth — Real asset base shrinking
Cash Flow Statement
- Negative or Erratic Operating Cash Flow — Core business instability
- Negative Free Cash Flow — Business consuming cash
- CapEx < 10% of OCF — Underinvesting in the business
- Rising Debt in Financing Cash Flow — Debt funding operations
- OCF < Net Income — Earnings not backed by cash
- Dividends > OCF — Unsustainable shareholder payouts
- Sudden Cash Drops — Lack of transparency
- Weak Cash Interest Coverage — Debt serviced without cash strength
- (OCF + Interest Paid) < 0 — Business not self-funding
Fiscal Investor perspective:
Red flags are signals — not verdicts. The danger lies in clusters, persistence over time, and deterioration across multiple statements. Financial strength is rarely lost all at once — it erodes quietly.