Financial Statements Of Corporates For Credit Risk Analysis

 Red Flags In Financial Statements Of Corporates For Credit Risk Analysis

Financial statements of corporates are crucial for making smart investment choices and credit risk analysis in banks. They include the balance sheet, income statement, cash flow statement.They reveal a company’s health and potential for growth. These are useful for investors, analysts, and other stakeholders to make informed decisions. However, financial statements can sometimes contain red flags – signals of potential problems or hidden irregularities. Knowing what these red flags are key to making informed decisions about investing or doing business with a company. ◼️BALANCE SHEET 1. High Debt Levels High levels of debt increase financial risk, especially if not aligned with sustainable earnings and cash flows. It can strain liquidity, increase interest expenses, and limit flexibility in challenging economic environments. 2. Negative Equity 3. Declining Asset Quality 4. Increasing Accounts Receivable 5. Unusual Inventory Levels Rapidly increasing or decreasing inventory levels may signal potential issues with production, sales, or obsolescence. Compare inventory levels to industry benchmarks. 6. Short Term Debt 7. Deteriorating Liquidity Ratios 8. Shrinking Profit Margins 9. Capitalising of R & D Expenses ◼️INCOME STATEMENT 1️⃣ Declining Revenues 2️⃣ Increasing Operating Expenses 3️⃣ Net Losses 4️⃣ Unusual Revenue Sources 5️⃣ Inconsistent Earnings 6️⃣ High Interest Expenses 7️⃣ Decline In Taxes 8️⃣ Aggressive Revenue Recognition 9️⃣ Heavy Reliance On Non Operating Income 🔟 Large One Time Expenses ◼️CASH FLOW STATEMENT 1. Negative Operating Cash Flow 2. High Capital Expenditures 3. Frequent Financing Activities 4. Mismatch Between Net Income And Cash Flow / Alarming Cash Flow Patterns 5. Negative Free Cash Flow 6. Large Dividends Despite Negative Cash Flow ◼️OTHER CRITICAL AREAS 1️⃣ Complicated Group Structures ( ie numerous subsidiaries, parent companies or affiliated entities) 2️⃣ Significant Changes In Accounting Policies & Estimates Sudden shifts in accounting policies can be a red flag. Ensure changes are adequately explained and don't serve to manipulate financial results. 3️⃣ Contingent Liabilities & Commitments 4️⃣ Frequent Changes In Auditors & Directors Frequent changes in auditors & directors may raise concerns. Stability in auditing relationships & directorships is generally a positive indicator of a company's commitment to transparency. 5️⃣ Unusual Accounting Practices 6️⃣ Poor Corporate Governance 7️⃣ Declining Market Share A shrinking market share could indicate increased competition or a loss of consumer confidence. Stay vigilant about the company's competitive positioning.