Spotting Red Flags in Your Financial Statements Before It’s Too Late
According to the AICPA, a staggering 61% of business financials contain a material misstatement. That means the numbers you’re sending to your board, investors, and stakeholders may be misleading—and in some cases, flat-out wrong. Even worse, you might be making crucial decisions based on those flawed numbers.
In this post, we’ll break down how to identify red flags in your financial statements, how to fix them, and how to maintain clean, consistent financials going forward—without necessarily needing a full-blown audit.
Why Most Financials Need Fixing
“Every time we open a new set of books—whether it’s for a $5M, $10M, or $25M business—there are material adjustments we make to correct the books.”
From inventory misstatements to duplicated expenses, inaccuracies in financials can cause major issues. For instance, one client had a $500,000 adjustment because their inventory wasn’t properly relieved from the balance sheet into cost of goods sold. It skewed their margins, disrupted ratios, and even impacted their tax filings.
Start with the Balance Sheet: A CFO’s First Stop
When looking through the lens of a CFO, always start with the balance sheet. Key things to watch for:
• Negative balances – Debit accounts with credit balances (and vice versa) typically indicate misclassifications.
• Stale accounts – Assets or liabilities that haven’t moved in months could be a sign of forgotten transactions or inaccurate entries.
• Assets = Liabilities + Equity – While rare in modern systems, it’s a red flag in any manual accounting setup.
Move to the P&L: Spot Anomalies
Next, review your Profit and Loss statement month over month:
• Are there large, unexplained swings in revenue or expenses?
• Are any entries duplicated—like a bill and its payment being recorded separately as expenses?
These kinds of errors can overstate expenses and liabilities, throwing off key financial metrics.
Watch AR and AP Balances Closely
“This is where your cash is coming from and where it’s going to.”
• Accounts Receivable (AR) – If AR is growing but sales aren’t, you may have a collection problem.
• Accounts Payable (AP) – A rising AP balance may indicate unpaid obligations or poor vendor management.
Ensure that cash flow isn’t being tied up unnecessarily in either.
Look Out for These Common Red Flags
1. Stale Asset Accounts
“We once saw a $340,000 asset sitting idle—not depreciated, not relieved. Just sitting.”
These kinds of assets should be investigated. If they’re not actively used or amortized, they can distort your balance sheet.
2. Payroll Tax Liabilities Not Clearing
“If liabilities from payroll aren’t reconciled monthly, they can balloon fast.”
Ensure that payroll taxes, healthcare, and other deductions are accurately recorded and cleared.
3. Duplicate Transactions
“Expenses can easily be duplicated when your bill pay system and your accounting software don’t sync properly.”
Always match bill payments to their corresponding bills. Otherwise, you risk overstating expenses.
4. Owner Expenses Recorded as Business Expenses
“We’ve seen everything from Netflix to personal meals classified as business expenses.”
If it’s a personal charge, reclassify it as an owner draw or distribution. Otherwise, your financials will reflect inflated operational costs.
Creating a Financial Review Process
So how do you keep all of this in check?
• Review your balance sheet monthly – Look for credit balances in debit accounts, stale accounts, and unexplained growth.
• Reconcile transactions weekly or monthly – Stay on top of your bank feeds and credit card activity.
• Validate with source documents – Especially for payroll and major expenses, reconcile reports with your accounting records.
“Businesses that review their financials monthly are 78% less likely to experience cash flow surprises.” — JPMorgan Chase Study
Build a Rhythm of Financial Oversight
By building a monthly rhythm of reviewing your financial statements, you stay ahead of issues before they become major problems. You’ll:
• Avoid nasty surprises at tax time
• Catch errors before they distort your metrics
• Build trust with your board, lenders, and stakeholders
Final Thoughts
The bottom line? Sloppy financials don’t just look bad—they can cost you dearly. By treating your books with the care of a CFO, you can make smarter decisions, reduce financial risk, and build a more sustainable, profitable business in 2025.
Start now. Start simple. Review often. And let the numbers guide—not mislead—you.
