Identify Red Flags In Your Small Business Financial Statements | Ep 7

🔍 How to Spot Red Flags in Your Financials & Avoid Costly Mistakes | Full Send CFO

👉 Link to YouTube Video

📢 61% of financials contain material misstatements. Are yours accurate? The financial reports you send to investors, stakeholders, and your board may be wrong—leading to bad decisions and financial surprises. In this episode, we break down:

✔️ How to identify critical errors in your financial statements

✔️ Common red flags that CFOs & accountants often miss

✔️ Why reviewing your financials monthly reduces cash flow surprises

✔️ Best practices to prevent reporting mistakes before they snowball

⏱️ Chapters

00:00 - Most Financial Statements Are Wrong—Here’s Why

00:26 - How Misstatements Lead to Bad Business Decisions

01:17 - Common Accounting Errors That Impact Financial Ratios

02:00 - Balance Sheet Red Flags: Negative & Stale Accounts

03:05 - P&L Red Flags: Duplicate Transactions & Anomalies

04:00 - AR & AP Risks: How to Catch Aging Balances Early

05:00 - Payroll Tax Liabilities: A Hidden Danger

06:37 - Duplicate Expenses: How Bill Pay Systems Cause Errors

07:49 - Owner Expenses: Why They Must Be Classified Correctly

08:30 - How to Fix These Issues: Monthly Review Strategies

09:32 - Why Businesses That Review Financials Monthly Perform Better

10:00 - Final Thoughts: How to Build a Financially Healthy Business

✅ Key Takeaways:

✔️ Negative balances and unclassified assets are red flags for accounting errors.

✔️ Aging AR & AP can indicate cash flow problems before they escalate.

✔️ Payroll tax liabilities must be actively monitored to avoid hidden debt.

✔️ Duplicate expenses from bill pay systems can quietly distort financials.

✔️ Regular monthly reviews reduce the risk of financial surprises by 78%.

📢 How do you ensure financial accuracy in your business? Drop a comment below!

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Full Send | Accounting & Data

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Transcript

[00:00:00] According to the AICPA, 61% of business financials contain a material misstatement, meaning that the financials that you're sending to investors, to your board, to your key stakeholders in the organization are probably wrong. Not to mention that the financial ratios that you're looking at may contain material issues that may be leading you to be making decisions that ordinarily you might not make if the numbers were correct.

[00:00:26] So we're gonna walk through how to identify red flags in your financial [00:00:30] statements, how to start to identify how to solve those issues, and then ensure that you have. Quality financials moving forward. Now, a hundred percent accuracy is, is always gonna be pretty challenging given the complexity and the volume of transactions in your business.

[00:00:45] However, if you can start to create a checklist on what to look at in order to identify some of these red flags, you may be able to avoid sending those financials that do contain a material misstatement without having to undergo a financial audit.

[00:00:58] I've spent enough time [00:01:00] around businesses and cleaning up their books to understand every single time that we open up a new set of books for a business, five, 10, even $25 million in revenue. There are material adjustments that we make in order to correct the books moving forward. For instance, we had a.

[00:01:17] About a $500,000 adjustment to a client that wasn't properly relieving their inventory from their balance sheet into cost of goods sold on their P&L, thus really messing with their financial [00:01:30] ratios on their balance sheet and on their cost of goods sold and margin side. It created a lot of challenges, and then ultimately having to take a one time hit of the financials that impacted their taxes.

[00:01:41] So we wanna be able to avoid that and look at the items on a month to month basis that could very quickly. Get outta hand, but then also can be remedied and things that you should be looking at on a regular basis to ensure that you are consistent, comparable, and accurate moving forward.

[00:01:55] So where do we wanna start? If we wanna look at this like A CFO, we're gonna start with [00:02:00] a balance sheet. We're gonna look at a balance sheet month over month and start to identify are there any negative balances? Are there any credit balances in a debit account or debit balances in a credit account that would be representative of a negative line item on your balance sheet?

[00:02:15] We don't wanna see that. That is not a good thing.

[00:02:18] That's generally an indicator that there is some sort of misclassification of the transactional accounting going into that account. Now, in the subledger, the detail that makes up that one account on your [00:02:30] financial statements, there may be credit or debit balances in incorrect accounts. However, you need to go down to the transactional layer and supporting documents to validate whether or not it should be.

[00:02:40] Classified elsewhere, but just as a rule of thumb, you shouldn't have negative balances on your balance sheet.

[00:02:45] Also, if assets doesn't equal liabilities, plus your equity, something's wrong. However, most accounting systems today ensure that that's not a problem. But if for some reason you're tracking your financials on Excel or some manual method of tracking your financials, [00:03:00] you wanna ensure that your total assets equals your total liabilities plus equity in the business.

[00:03:05] The next thing we wanna do is move to the P&L and just take a, a really high level look on your month to month revenue, your month, month expenses, and see if there are any like really big anomalies that come out in the account detail. What you can often find is that there are. Duplicate entries in expenses in your revenue because of maybe duplicate invoices that that were recorded in the system.

[00:03:27] Maybe it was a bill and then an [00:03:30] expense wasn't matched the bill and they were duplicated in your expenses. But just by simply going on a month to month basis and taking a look at some of the movements in the account, we'll help you identify if there are any issues on the P&L.


[00:03:41] So now that we've taken a look at the balance sheet and the profit and loss statement, what are some areas that we really wanna hone in on to make sure that are accurate moving forward? I like looking at AR and AP balances. Ultimately, this is where your cash is coming from and where it's going to, and what's owed to people and what's owed from customers at any [00:04:00] point in time.

[00:04:00] As we mentioned previously, you don't want to have negative balances on your balance sheet, but we wanna look at your AR and AP balance to ensure that there's movement there and things aren't aging in either of those accounts. If you're aging your AR and that balance just continues to increase without sales necessarily increasing, that means we have an issue.

[00:04:19] If your AP balance is increasing.

[00:04:21] That means that we really haven't taken the time to start paying down our liabilities to our vendors. And so we wanna take a look at the, the relationship between those accounts, your cash balance, [00:04:30] and then ensure that we have consistency in those accounts moving forward. One thing that we often see on balance sheets when reviewing financials is that there are stale accounts with no activity.

[00:04:41] So what tends to happen is an accountant or maybe yourself has put some sort of an asset on the balance sheet, and it just hasn't moved in months, maybe years, in some cases. We recently looked at a set of books that had a $340,000 asset on the account, and nothing was happening with it. It wasn't being depreciated, it wasn't [00:05:00] an asset that was.

[00:05:00] Prepaid and being relieved into the P&L. It was just sitting there. And so we wanna take a look at these accounts to understand the validity of them and why they're on the balance sheet. But generally it's a red flag if you have stale accounts that really just aren't moving at all, particularly on a year over year basis.

[00:05:17] Some of the hidden issues that are really easily overlooked by experienced accountants and CFOs are things like a payroll tax liability not clearing out. So what I mean by that is that every single [00:05:30] month. Bimonthly. You have payroll going out and you are making payments to healthcare, to taxes, other payroll liabilities outside of the payroll process.

[00:05:40] So your payroll system is typically recording a liability for those payments, meaning that you owe money to healthcare, you owe money for taxes. You owe money for these different obligations that oftentimes is paid separately from the payroll rhythm. And so what happens is that the payroll system can very quickly.

[00:05:59] Be [00:06:00] booking these liabilities and not actually matching the actual dollars going out the door for the benefits or payroll liabilities that you're responsible for. And that can result in a really big liability balance over time if it's not monitored and matched on a timely basis. So what we need to do is we need to go to underlying payroll records and.

[00:06:20] Payroll reports in order to validate that against what's happening on the accounting side so that we can reconcile the payroll account on a monthly basis. I [00:06:30] mentioned this earlier, but duplicate transactions are often found in the financial statements, and here's why. What will happen is that you typically have a system that's 

[00:06:37] invoicing on your behalf, or a system that you pay bills through on your behalf, or a system that's set up for your bill pay process that syncs to your general ledger, that may sync to your QuickBooks file.

[00:06:48] And what happens is on the QuickBooks side, when that money goes out to pay the bill. Oftentimes, accountants will take that transaction, that cash transaction, and code it directly to an expense. [00:07:00] However, when your bill pay system recorded that expense, it recorded it through a bill, meaning the bill was recorded on your P&L as an expense, and then when the accountant came in, they saw the cash transaction.

[00:07:12] They didn't match it to the bill. They actually just coded it directly to an expense account, meaning that the expense were duplicated on the P&L, thus overstating your total expenses.

[00:07:21] and overstating your future liabilities because the bill wasn't cleared out.

[00:07:26] Now the last thing that we often see that is probably more common with [00:07:30] smaller businesses is just looking at the, the glut of owners' expenses and having those being classified as operating expenses for the business. We've seen Netflix transactions, we've seen other personal expenses that we won't mention here, uh, as well as other seemingly business type meals and entertainment, but in reality, they were.

[00:07:49] Owner expenses, they were not business expenses. And so when that occurs, those types of expenses, a shouldn't be on the Financial statements, they should be going through the [00:08:00] owner's personal accounts, but if they do, we do wanna make sure that they're classified as distributions to the owner.

[00:08:05] 'cause ultimately that's kind of what it is, you're, the business is paying an an amount out on behalf of a benefit to the owner that's not business related. Thus, it should be categorized as a distribution to the owner in the amount incurred.

[00:08:19] So how do we remedy these situations? How do you actually ensure that, that you're catching these things before they build up and cause a big material issue? Trust me, you do not wanna have to reconcile a [00:08:30] payroll liability after months and months and months of neglecting it. It is not fun. So what you can do is you can start to review your balance sheet monthly to identify credit balances and debit accounts for stale accounts over time.

[00:08:42] And start asking questions about them and or dig into the root cause of what's actually happening in those accounts. You need to have a process set up to be reviewing your financials monthly and ensuring that you're clearing out the transactional activity in your bank feed on a regular basis, meaning as transactions occur on your bank accounts [00:09:00] and on your credit cards, you are taking a look at the transactional detail and categorizing it onto your P&L, onto your balance sheet as appropriate.

[00:09:07] Just keeping up with that rhythm on a weekly. monthly basis will help you stay on top of your financials, ensuring that those issues don't pop up in the future.

[00:09:15] a JP Morgan Chase study found that businesses that review their financials monthly are 78% less likely to have cash flow surprises in their business. That's not even having a cash flow forecast set up is just reviewing financials monthly and staying [00:09:30] in tune with what's happening in the business.

[00:09:32] So if you can set up a cadence and a rhythm of reviewing your financial statements, you'll by nature be ahead of the game and be more well equipped to encounter any cash challenges that may come your way because you have a little bit more familiarity with your books I hope that's a helpful overview on how to think about your financial statements of what can cause them to raise some red flags with outside parties, with your own management team.

[00:09:53] Ultimately, we wanna help you grow a more profitable, sustainable, and healthy business in [00:10:00] 2025 more next time.