RED Flags

“Immaterial” Differences.

In finance, 'red flags' refer to warning signs or indicators that something may be wrong or require closer attention. These can signal potential risks, problems, or unethical practices within financial statements, transactions, or business operations.

Identifying red flags is crucial for preventing financial losses, fraud, compliance issues or obtaining accurate financial reports.

Inaccurate numbers can adversely affect your decision-making in areas such as margins, cash flow management, company valuation and fundraising

🚩Impact: Misleading Financial Reporting

🚨Risk: Fraud, Wrong Valuations and Incorrect Budgets & Forecasts

📊Issue: Any discrepancy between two sets of data indicates incorrect numbers. It cannot be dismissed as "immaterial" if the cause is unknown.

Only auditors can make judgements based on the materiality.

! Materiality doesn't apply to companies because:

  • The finance team is responsible for accounting for every “penny” in the company

  • Most importantly, any difference, even if deemed "immaterial", indicates an underlying issue

💡Solution: Investigate discrepancies, resolve them and introduce processes and controls to prevent future occurrences.

🤷‍♂️Questions to ask:

  • What is the cause of the difference?

  • Why haven't the differences been resolved?

  • How can materiality be assessed without investigating the difference?

💼 Example: Sales volumes from the website don't match those recorded in the accounting system. This might be due to:

  • Inaccurate input reports used for uploading to the accounting system

  • IT bugs causing data synchronisation failures

  • Incorrect data filters used by the finance team when extracting reports from the website

  • Duplicated sales entries from either website synchronisation or report downloads

  • Fraud: Sales can redirected and partly be collected outside of the reporting system.

Persistent Overdue Cash Collection.

📊 Impact: Negative Working Capital

⚠️ Risk: In the short-term, it is challenging to meet operational expenses, pay suppliers, or invest in growth opportunities. Over time, may erode financial stability.

📝 Issues: These can be indicators of the following problems:

  • Unclear payment terms in contracts or invoices

  • Receivables payment terms might need to be revisited to align with supplier terms

  • Inefficient invoicing due to lack of automation in issuing invoices and sending reminders

  • Lack of automated systems for tracking payments, causing incorrect allocation of cash collection, which creates disputable balances and adds time for reconciliation with customers

  • Poor follow-up processes: relying on emails instead of calls, not involving the sales team with difficult client

  • Poor credit management due to lack of robust KYC procedures during client onboarding

  • Poor communication of changes to company details such as company name, legal address or bank details

  • Disputes over services or products

  • Customers' financial struggles, where the company should consider ceasing services or product supply

🛠️ Solution: Ensure that:

  • Introduce clear payment terms and communicate them upfront

  • Strengthen credit checks before extending terms

  • Resolve customer disputes quickly to avoid delays

  • Automate invoicing and reminders with software to ensure timely follow-ups

  • Follow up with a phone call

  • Involve sales people for disputable accounts

  • Offering early payment discounts or introducing penalties for late payments can also help

❓ Questions to Ask:

In the growing stage of the business:

  • How often does company review payment terms and working capital processes?

  • Has company automated invoicing issuance and follow-up procedures?

  • Are staff trained in proactive cash collection techniques?

  • Does staff regularly reconcile balances with customers?

  • Are salespeople involved early enough to help resolve disputable balances?

  • Is a robust KYC process in place to ensure effective credit-checking for new customers and review of the credit score for existing customers?

  • Are payment terms clearly outlined and understood by customers?

  • Is the finance team following up on overdue invoices in a timely manner?

  • Are disputes or queries from customers causing delays, and how are they being addressed?

📌 Example:

A mid-sized B2B company faced persistent overdue receivables, causing cash flow shortages. After implementing automated invoicing and reminders, establishing stricter credit policies, and training their finance team to handle disputes effectively, they reduced overdue receivables by 40% in six months.