How to use financial statements to gauge red flags and possible insolvency (don’t wait till too late)

It is acknowledged that financial statements are the organs that best retain evidence of the cause of corporate insolvency. What this mean is that in order to look into the future of a business, financial statements will provide enough clues to it way ahead of time.

Why is this important? It is important because if you are going to manage your business for the longer haul, it is important to know what is ahead as much as possible. Of course, one cannot predict everything that may happen that will mess up a business no matter how prepared we are but at least the financial statements can be a good guide to what is possible.

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There are several different ways to analyze a financial statement but here are a few key indicators that could be very helpful to you in a quick way. In managing a successful business, you want to be able to be alerted on major and significant changes.

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1.???Always look at your cash position

Did you notice that in your Cashflow Statement, there is this line called “Cash and Cash Equivalent”? Do you know what it means? It represents your business’s assets that are cash or can be quickly converted to cash. They are the most liquid short-term assets and are reported on the asset side of a company's balance sheet.

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The aggregation of this ““Cash and Cash Equivalent” should exceed your total debt. Note that currently there are many businesses who are facing rising debts, and some are swamp with their inability to service their debts. With uncertainty about the direction of interest rate, this is becoming an extremely challenging point to manage. If your “Cash and Cash Equivalent” is lower than your total debt, you need to take note.

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2.???Watch your inventory or number of employees

If you are managing a product-based business, you need to take note of the inventory level. Or if you are in the service-based business, you take note of the number of your direct employees.

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The point is that your inventory value or direct employee cost should not significantly be higher than the revenue generated. Yes, you need to keep certain level of inventory or direct employees but watch out if over time, the Revenue Per Dollar of Inventory or Revenue Per Direct Employee is on a downward trend.

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3.???Track your Account Receivables carefully

This is one indicator that you should keep a close monitoring on. Account Receivables represents the inflow of your cash based on collection. So, unless you collect your revenue, they remain outstanding, and a growing outstanding amount will choke your ability to pay and sustain your business.

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So do not allow your Account Receivables to raise faster than your revenue. Keep an active aging on the outstanding amount. Be very judicious on giving longer than necessary credit terms, choose your customers carefully and do not depend just on a few major customers.

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?In today’s business environment, whether you are dealing with some short- or long-term situation, you need to stay vigilant and be very careful. In this way you can stay ahead of possible and bumpy financial challenges. Being ahead allows you the opportunity to react. This is a big advantage to keep your business solvent. But if you do not have advance indicators to help you to steer clear of dangers ahead, no amount of protection will help.