Sunday, October 28, 2012

The Financial Red Flags in negotiations

The Financial Red Flags

In negotiations, wouldn’t it be great to know what the other side is looking at before you start negotiating? What are the words that would trigger them, what are they looking at that tells them to trust you or not?

When you are looking to get financing from an outside source, it might be helpful to know what are the financial red flags that will raise their concerns. Lucky for us, people who used to be investors or worked at banks have written about it, so now you know, ahead of time, what they are looking at.

The annual report
A business report has to be straight forward – you buy or manufacture something, sell it and make a profit. When the business report is complicated and cannot be understood in simple terms, something is might be hidden.

Cash flow and earnings
Another sign that something might be amiss is when the operating cash flow is not equal or greater than net profits. The reason most companies are dragged down is not lack of profits but the absence of cash flow. The only reason for that not to happen is in case the company is growing and investing in working capital.

Restatements of past financial periods
Sometimes restatements have to do with changing accounting policy. However, when the company restates income that is much higher than the previous statements it raises red flags.

Recurring unusual expenses
If the company has a lot of expenses grouped under “extraordinary expenses” for previous reporting years, it’s a worrisome sign. It makes sense if it happens once or twice when the company grows, but having it year after year feels like something is hidden there.

Transaction between related parties
You would expect that there would be no transactions between the company and its directors or management, directly or indirectly. Related party transactions give the feeling that the management is trying to enrich itself instead of worrying about the company.

Large amounts are categorized as “other income”
The annual report may be trying to hide the real state of the company with an injection of income not related to the operation of the company; hence it’s called “other” income.

Directors and management pay
In today’s world the relationship between management and employee’s pay has changed dramatically, so pay that is hundred times the amount of a salary is acceptable, in some circles. But, consulting fees that are paid to directors or retired management are a way to bleeding the company dry.

Here’s another secret: There are some key words that raise financial red flags. Today, when most annual reports are filed electronically, it is even easier than before to zoom through the application or proposal by using keyword search. “Related Party”, “Restatements”, “Bill and Hold”, “Extraordinary”, “Percentage of Completion”, “Unbilled Receivables” “Change in revenue recognition” and “consulting relationship” are some of those, and might be in the way of you getting the financing you are seeking.


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