How to spot financial red flags in board papers is a hot topic for me. When I’m facilitating the finance module of the Australian Institute of Company Directors’ Company Directors Course, one question consistently raised by participants—especially those without a financial background—is this:
“How will I know if something is wrong in the financials?”
It’s a great question. And a really important one. As directors, we’re accountable for the financial sustainability of the organisations we govern. That means we can’t afford to ignore the numbers—or rely on everyone else to tell us if there’s a problem. We know how that panned out for the Centro directors!
The attached article from the Australian Institute of Company Directors is both a reminder of our duties and a practical guide to spotting some of the early warning signs that might deserve a second look.
Start with your obligations as a Director
The Corporations Act doesn’t differentiate between finance and non-finance directors when it comes to your legal responsibilities.
Directors are expected to understand, analyse and interpret financial reports—regardless of their background. That means being able to stand by your legal responsibility to state that these financial statements represent a “true and fair view”.
Ask yourself these questions:
- Do they tell the story that is consistent with what I understand is going on with the organisation?
- Have we missed anything out?
- Are they accurate? Do I know how we determined the assets are valued correctly – especially the subjective ones like intangibles and mining assets?
- Are they written in a language that I understand, and our Members are likely to understand?
That means relying solely on management, or the accountant on the board, or the auditors isn’t good enough. You have to form your own view.
And if you don’t understand the financial papers being presented to the Board, that in itself can be a red flag. You either need to build your capability and/or work with the Chair and Executive to ensure the information being presented is clear, relevant, and fit for purpose.
Don’t bury your head in the sand – get some financial literacy training
This is where it starts. The ability to identify red flags comes from having a basic level of financial literacy.
You don’t need to become a finance expert. But you do need to understand:
- How to navigate a set of financial statements. Specifically, how to read a balance sheet, profit & loss statement, and cash flow statement, and understand the inter-relationships between these statements.
- Key ratios and what they tell you about the organisation’s health.
- The difference between cash and profit.
- The financial assumptions that underpin the numbers in the financial statements, budgets and forecasts
If you’re not there yet, get some help. That might be formal training, like one of the AICD courses, or many others available. Most of the audit and advisory firms also run free training for their clients. It might be asking the CFO to take you through the accounts in more detail, or running a board briefing session. Or it might be spending time with a fellow director who has an accounting background. Or inviting yourself to the Finance and Audit sub-committee.
Financial literacy is a skill—and like any skill, it can be learned and also needs to be put into practise.
Back yourself – if something doesn’t sound right, it probably isn’t
Listen to your gut
- Maybe it’s a set of results that seem too good to be true.
- When I hear the explanation “it’s just timing differences” I always ask more questions.
- Maybe the explanation is overly complicated, written in accounting language, or completely inadequate
- Something may be completely at odds with your understanding of the situation.
- Or, something that’s popped up “out of the blue”. Eg: last month the results were on track and suddenly they’re not.
These are the moments to stop and ask questions. And you’ll often find others in the room are also a bit puzzled—they’re just waiting for someone else to ask the question. It may as well be you.
Ask questions – especially the “silly” ones
I can’t tell you how many times I have experienced a fellow director or a Company Directors Course participant apologising before asking a question. I’ve done it myself. But, that question can sometimes be “gold” opening a “can of worms” that gets to the heart of the matter.
If something in the board papers and financial statements doesn’t make sense to you, it’s your duty to explore it further. Remember, as the board of directors we’re ultimately responsible that the financials represent a true and fair view, and that we’re confident that we can pay our debts as and when they fall due. And this is not just an annual requirement when we sign the audited financial statements. This applies all of the time.
There’s no such thing as a silly question if it helps the Board fulfil it’s responsibilities
If anything, the willingness to ask simple, direct questions is a hallmark of a good independent director.
Recognise the signs of inadequate reporting
Sometimes the red flag is the financial report itself.
If you receive financial papers that are inconsistent, late, overly detailed or filled with unexplained variances—it’s a sign the business may be lacking financial management or governance expertise.
Other signs to watch for include:
- Excessive use of jargon without explanation.
- Too much information. Pages and pages of irrelevant detail that make it hard to see “the wood from the trees”.
- A focus on narrative over numbers (i.e. “trust us, everything’s fine”). It’s a balance – the Board need a written summary plus numbers presented in an easy to understand format.
- Repeated deferral of financial or audit reports.
- Limited visibility of cash flow or future liabilities. You want a cash flow forecast and balance sheet.
- Inability to provide budget-to-actual comparisons with explanations of variances that go beyond “timing differences”.
Inadequate reporting undermines your ability as a Director to make informed decisions. If the information isn’t good enough, speak up. The Board has a right—and a responsibility—to demand better. The Centro case taught us that too.
Engage with the CFO, finance sub-committee, and auditors
Good governance is a team effort, and directors are allowed (and hopefully encouraged) to use the resources available to them.
- Ask the CEO and/or CFO to walk you through the numbers or provide context or further explanation where you need it.
- Attend the finance or audit sub-committee—even if you’re not a formal member. You’ll hear more detailed conversations and may feel more comfortable asking questions.
- Engage with the external auditor—ensure they attend both the finance/audit sub-committee and board meetings. Ask questions. If they can explain to you in a language you understand how they were satisfied that eg grant revenues were recognised correctly, it will aid your understanding. But, auditors don’t get it right all the time – they’re only human! You still need to apply your own judgment.
Final thoughts
Spotting financial warning signs isn’t about having a background in accounting, being familiar with all of the Accounting Standards or being an Excel whizz. It’s about knowing enough and having the confidence to ask questions. Recognising when something doesn’t “add up”, and being willing to challenge what’s presented. To ask that “silly” question.
I typically share with Australian Institute of Company Directors course participants that you don’t need to be an accountant to look at two columns of numbers, compare them, notice what’s changed significantly and then ask yourself:
- Is that good or bad?
- Do I know why?
- Is that what I was expecting based on my knowledge of what’s going on?
- If not, seek an explanation.
It’s also about creating a culture around the board table where these conversations can happen freely—without fear of looking foolish or overstepping.
As a Director you’re not there simply to rubber stamp the numbers. You’re there to ensure the organisation is not trading whilst insolvent, is financially sustainable, and the finances are well-managed. In fulfilling your obligation to act in the best interests of all stakeholders, you need to be confident that the financial statements are representing the real story. Nothing omitted. Nothing embellished.
“A reading of the financial statements by the directors is not merely undertaken for the purposes of correcting typographical or grammatical errors or immaterial areas of arithmetic. The reading of the financial statements by a director is for a higher and more important purpose: to ensure that the information included therein is accurate”
Justice Middleton – Centro Case judgment
You can find the full AICD article here.
