Red flags: the quiet killers

By the end of this lesson

Fifteen specific red flags, ranked by how much they should worry you
Where in the filings each one is found
How to weigh a single flag against a cluster of them

You are not going to catch a determined fraud, and you don't need to. Your goal is more modest and far more achievable: notice when a company looks different from a healthy one, and decline to own it. There are always other companies.

The one thing

One red flag is a question. Three red flags in the same company is an answer. Look for clusters, not individual items.

Tier 1 — walk away and don't negotiate

The severe ones

Auditor resigns mid-term
Where to find it: Exchange filings
Why it's serious: Auditors rarely quit a paying client. When they do, they've seen something they won't sign.
Qualified audit opinion
Where to find it: The audit report in the annual report
Why it's serious: The auditor is formally stating that part of the accounts cannot be relied upon.
CFO leaves repeatedly
Where to find it: Exchange filings
Why it's serious: Two or three CFOs in three years means the person who signs the numbers keeps declining to.
Promoter pledge above 50%
Where to find it: Quarterly shareholding pattern
Why it's serious: A falling price can force lenders to sell the promoter's shares, driving the price further down.
Profits with persistently negative CFO
Where to find it: Cash flow statement
Why it's serious: Reported earnings are not becoming money, year after year.
Large loans to related parties
Where to find it: Notes to accounts
Why it's serious: The most common route by which cash leaves a listed company and doesn't come back.

Flag	Where to find it	Why it's serious
Auditor resigns mid-term	Exchange filings	Auditors rarely quit a paying client. When they do, they've seen something they won't sign.
Qualified audit opinion	The audit report in the annual report	The auditor is formally stating that part of the accounts cannot be relied upon.
CFO leaves repeatedly	Exchange filings	Two or three CFOs in three years means the person who signs the numbers keeps declining to.
Promoter pledge above 50%	Quarterly shareholding pattern	A falling price can force lenders to sell the promoter's shares, driving the price further down.
Profits with persistently negative CFO	Cash flow statement	Reported earnings are not becoming money, year after year.
Large loans to related parties	Notes to accounts	The most common route by which cash leaves a listed company and doesn't come back.

Tier 2 — investigate before going further

The ones that demand an explanation

Receivables growing much faster than revenue
Where to find it: Balance sheet vs P&L
What it may mean: Sales pushed on credit, or booked before they're real
Inventory growing much faster than COGS
Where to find it: Balance sheet vs P&L
What it may mean: Demand slowing; a write-down may be coming
Other income above ~25% of PBT
Where to find it: P&L
What it may mean: Profit isn't coming from the business
Effective tax rate far below ~25%
Where to find it: P&L
What it may mean: One-off benefits or aggressive positions that reverse later
Frequent "exceptional items"
Where to find it: P&L
What it may mean: Exceptional every year is not exceptional — it's the business
Capitalising costs that peers expense
Where to find it: Notes / accounting policies
What it may mean: Moves spending off the P&L and onto the balance sheet, flattering profit
Repeated equity issues with flat EPS
Where to find it: Share capital, EPS
What it may mean: Owners keep funding a business that doesn't fund itself
Promoter holding falling steadily
Where to find it: Shareholding pattern
What it may mean: The people who know most are reducing their exposure
Large, growing contingent liabilities
Where to find it: Notes to accounts
What it may mean: Off-balance-sheet obligations that can become real debt

Flag	Where to find it	What it may mean
Receivables growing much faster than revenue	Balance sheet vs P&L	Sales pushed on credit, or booked before they're real
Inventory growing much faster than COGS	Balance sheet vs P&L	Demand slowing; a write-down may be coming
Other income above ~25% of PBT	P&L	Profit isn't coming from the business
Effective tax rate far below ~25%	P&L	One-off benefits or aggressive positions that reverse later
Frequent "exceptional items"	P&L	Exceptional every year is not exceptional — it's the business
Capitalising costs that peers expense	Notes / accounting policies	Moves spending off the P&L and onto the balance sheet, flattering profit
Repeated equity issues with flat EPS	Share capital, EPS	Owners keep funding a business that doesn't fund itself
Promoter holding falling steadily	Shareholding pattern	The people who know most are reducing their exposure
Large, growing contingent liabilities	Notes to accounts	Off-balance-sheet obligations that can become real debt

The two-minute forensic sweep

Run this on any company before you go deeper

1Five years of PAT next to five years of CFO. Do they move together? If profit rises while cash doesn't, stop here and find out why.
2Receivables and inventory growth vs revenue growth. Both should be roughly in line. Either one running well ahead is a finding.
3Other income as a share of PBT. Above a quarter, the business is not the source of the profit.
4Promoter pledge, from the shareholding pattern. Any pledge at all warrants a look; above 25% is a serious constraint on your position.
5Search the notes for "related party". Read what's there. Large loans or sales to promoter-owned entities are the single most productive place to spend two minutes.
6Check auditor and CFO continuity. Any change in the last three years — find out why.

Worked exampleA cluster, seen in the numbers

One company, five years. No single line is proof. Together they are a portrait.

Reported PAT: up 68% over 5 years
Cumulative CFO ÷ PAT: 0.31
DSO: 51 → 128 days
Total debt: ₹300 Cr → ₹910 Cr
Other income share of PBT: 31%
Promoter pledge: 12% → 47%
Auditor: changed twice

Profits rising → the story everyone reads

Cash not arriving → the profits aren't real money

Customers paying slower → sales quality falling

Debt tripling → the gap is being funded by lenders

Promoter pledging more → the owner is borrowing against his own shares

Auditors leaving → the people who check the books keep resigning

So → Every one of these was in a public filing, free, months or years before any headline. No forecasting was required — only reading. That is the entire value proposition of forensic analysis.

The Beneish and Piotroski shortcuts

Worth knowing

Two academic scores worth knowing about

The Piotroski F-Score rates a company 0–9 on nine simple yes/no financial-health tests — profitability, leverage, operating efficiency. Scores of 8–9 indicate improving fundamentals; 0–2 indicate deterioration. It is genuinely useful as a fast screen and completely mechanical.

The Beneish M-Score combines eight ratios designed to detect earnings manipulation, built from the kinds of distortions manipulators produce: receivables running ahead of sales, margins deteriorating, costs being capitalised.

Neither is an oracle. A high F-Score doesn't make a company a good investment, and the M-Score produces false positives on fast-growing companies. Use them the way a doctor uses a blood test: a number that tells you where to look, never a diagnosis on its own.

Where people lose money

The story is always better than the numbers

Companies with problems in their accounts almost always have an outstanding story: a new sector, a policy tailwind, a visionary founder, an enormous order book, a stock that has already multiplied.

That isn't a coincidence. A great story is what makes people stop checking. The correlation between narrative quality and accounting quality, at the extremes, is often negative.

The discipline is simple and difficult: run the same forensic sweep on the exciting company as on the boring one. Especially when everyone you know already owns it.

What clean looks like

✓Cumulative CFO close to cumulative PAT over five years
✓Working-capital days flat or improving
✓Same auditor, same CFO, for years
✓Zero promoter pledge
✓Related-party transactions small and clearly explained
✓Tax rate near the statutory rate

What deserves a pass

✕Profits rising, cash flow falling
✕Receivables or inventory days climbing every year
✕Auditor or CFO churn
✕Rising promoter pledge
✕Large unexplained loans and advances to group entities
✕A tax rate nobody can account for

See it live · Every fundamental report here runs a forensic layer — F-Score, pledge, dilution, other-income share, debtor-day trend and tax anomalies — and severe findings cap the overall score no matter how good the rest of the business looks.

See red-flagged stocks →

In one screen

1Tier 1 flags — auditor exit, qualified opinion, CFO churn, heavy pledge, negative CFO with positive PAT, related-party lending — are reasons to walk away.
2Tier 2 flags demand an explanation you can actually find in the filings.
3Run the two-minute sweep on every company, especially the exciting ones.
4Look for clusters. One flag is a question; three is an answer.

Check yourself

Nothing is scored or stored — the explanation after each answer is the point.

1/2

Which single item would most justify walking away without further work?

2/2

A company shows rising profits, falling operating cash flow, rising debt and rising promoter pledge. What's the correct read?

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Who owns it, and are they leaving?

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