Step 9: Red Flags
Now it’s time to check for red flags signaling a potential earnings shortfall in the current or next quarter and for yellow flags warning of longer-term problems. At your option, you can compare net income to operating cash flow, and if your candidate passes that test, skip the accounts receivables and inventory tests.
A slowdown in historical year-over-year sales growth rates is a red flag, but if it exists, you would have discovered it in Step 8. In this section, you’ll compare forecast sales growth rates to historical trends. It’s a red flag if the forecast sales growth rates are significantly below historical levels.