Harbor Coffee, our fictional coffee business, grows sales by 4.76% from FY2 to FY3. Its net customer receivables grow 5.56%. Unpaid balances are edging ahead of sales.
Is Harbor waiting on a large sale made just before year-end, or are customers taking longer to pay? A late-year sale and a late payment can leave the same clue on the balance sheet. The invoice dates and payment terms help tell them apart.
A warning asks for an explanation
An accounting red flag is a financial pattern that deserves a closer look. It is a prompt to investigate, not a finding of fraud or an automatic sell signal.
Size, persistence and business context matter. A gap that widens year after year deserves more attention than a small change at one year-end. The revenue lesson separated earned sales from collected cash; the question now is whether that gap is widening.
Start with the mismatch, try a business explanation, then look for evidence that could challenge it. This puts the habit of checking your first impression to work on the accounts.
Check sales against unpaid bills
All dollar amounts below are in millions and come from Harbor's reported figures. Full-year revenue rises from $1,050 in FY2 to $1,100 in FY3. Net receivables rise from $90 to $95 at those year-ends; these customer balances deduct an allowance for expected credit losses.
- Revenue growth: $50 ÷ $1,050 = 4.76%.
- Receivables growth: $5 ÷ $90 = 5.56%.
The gap is about 0.8 percentage points. Receivables are a year-end snapshot; revenue covers the whole year's sales.
A large late-year sale or a shift in seasonal shipments could explain the difference. Longer payment terms can also delay cash without making a bill overdue. Unpaid and overdue are different things.
Look for the revenue policy, credit-loss allowance and any receivables aging—a breakdown by how long bills have been outstanding. Compare aging and payment terms across years. An increasing overdue share or steadily lengthening terms deserves closer attention.
Check stock on hand and cash
From FY2 to FY3, year-end inventory rises from $110 to $115: $5 ÷ $110 = 4.55%. Annual cost of revenue rises from $630 to $660: $30 ÷ $630 = 4.76%.
Coffee on a shelf is recorded on a cost basis, subject to write-downs. Revenue uses the selling price. Compare inventory with costs as well as sales. Harbor's inventory grows more slowly than both; the bars show how small the differences are.
An inventory buildup can come from planned stocking or higher input costs. Read the inventory policy and management's explanation before blaming weak demand. Valuation choices affect both inventory and cost of sales.
For cash, take a longer view. Across FY1–FY3:
- Operating cash flow (OCF): $161 + $170.5 + $180 = $511.5.
- Net income: $135 + $142.5 + $150 = $427.5.
Operating cash flow exceeds profit by $84. The cash-flow reconciliation explains it: depreciation and amortization add back $36 + $38 + $40 = $114, while operating working-capital changes use $10 a year, or $30. The difference is $114 − $30 = $84.
This gap is explained. It does not certify the rest of the accounts.
Check the explanations themselves
A “one-time” expense that returns every year deserves a better name. Compare several years of adjusted-earnings reconciliations to see what keeps disappearing from the headline result. An unusually large expense can still be part of running the business.
The US SEC's guidance on adjustments warns about changing adjustments between periods without explanation and excluding unusual losses while keeping unusual gains. Consistency matters in both directions.
Harbor's FY3 balance of $100 combines goodwill and other intangible assets. Goodwill comes from acquisitions, so start with what was bought and the impairment review—whether the amount on the books needs reducing. The case supplies neither a breakdown nor those notes.
A retiring chief financial officer (CFO) and an auditor leaving after an accounting dispute tell different stories. Read the underlying filing for disclosed disagreements. A planned retirement changes the team; a warning against relying on past accounts challenges the statements themselves.
Read the audit report's explanation, too. A qualified opinion flags a specific exception; a disclaimer means the auditor gives no opinion. A material weakness means controls have a serious flaw that could let a significant reporting error go undetected. Find the affected accounts and the proposed fix.
Write the follow-up question
Each pattern points to different evidence:
| Pattern | Ordinary possibility | Evidence to check |
|---|---|---|
| Receivables outpace sales | Late sales | Aging; payment terms |
| Inventory builds | Planned stocking | Inventory note; MD&A |
| Profit and cash diverge | Noncash expenses | OCF reconciliation |
| Exclusions repeat | Multi-year project | Prior reconciliations |
| Large goodwill balance | Past acquisition | Deal; impairment notes |
| Auditor or CFO changes | Routine succession | Event filing |
For Harbor, a useful follow-up is:
Net receivables grew about 0.8 percentage points faster than sales from FY2 to FY3. Did late-year sales cause the gap, or did collections slow? The missing evidence is the two years' receivables aging and payment terms.
Harbor's case supplies neither disclosure, so the cause remains unknown. Bills shifting into older overdue groups would strengthen the concern. Recent invoices still within unchanged terms would support the timing explanation.
Harbor's small gap leaves a narrow question. Next, the 15-minute financial health check tests a different company whose sales, cash and debt give conflicting signals.
In short
- A red flag starts an investigation; it does not establish wrongdoing.
- Unpaid bills and overdue bills are different things.
- Compare inventory with costs as well as sales, and reconcile cash with profit across several years.
- A recurring “one-time” charge needs a better explanation.
- A useful follow-up names the missing evidence and what would change your view.