Many SME IPOs in India get delayed, downsized, or post‑listing wealth‑destroyers because promoters ignore clear red flags hiding in their own financial statements. Before you start your SME IPO journey, use the following 12 checks as a practical pre‑mortem on your numbers.
1. Inconsistent numbers across periods
- Sudden spikes or drops in revenue, margins or key expenses in the 4–8 quarters before IPO, without a solid business explanation, suggest window dressing or unstable business economics.
- Profit and loss, balance sheet and cash flow not reconciling year‑on‑year or quarter‑on‑quarter is a classic warning sign that will trigger SEBI/merchant banker queries.
2. Cash flow not matching “profits”
- Positive PAT but chronically weak operating cash flow (OCF) or cumulative OCF far below cumulative PAT indicates aggressive revenue recognition or poor collections.
- Rising receivables and inventory days with stagnant or falling operating cash is a sign that sales are parked with channels or customers are not paying on time.
3. Abnormal receivables and payables
- Debtors days much higher than industry, large overdue receivables or frequent write‑offs point to weak credit discipline or possible round‑tripping.
- Very low or suddenly reduced creditors days, especially just before IPO, may indicate pre‑payments to dress up profitability and relationships.
4. Inventory red flags
- Big build‑up of inventory without matching order book or sales growth raises risk of obsolete or unsaleable stock.
- Mismatches between stock records and physical verification, or frequent “shrinkage” and adjustments, indicate poor controls or potential fraud.
5. One‑off and “other income” dependence
- A large share of profits coming from non‑core or non‑operating items (asset sales, incentives, forex, fair value gains, “other income”) makes earnings low‑quality and unsustainable.
- Frequent “exceptional” items which conveniently boost reported PAT in the run‑up to IPO are a clear governance red flag.
6. Aggressive accounting policies
- Liberal revenue recognition (booked before delivery/acceptance), capitalization of routine expenses, or heavy reliance on adjusted EBITDA/pro‑forma numbers are classic window‑dressing tools.
- Frequent changes in accounting policies or estimates (depreciation, useful lives, provisioning norms) which flatter current profits should be treated with high caution.
7. Weak audit trail and qualifications
- Qualified/modified audit opinions, Emphasis of Matter on going concern, internal control weaknesses, or delays in finalizing audited accounts will immediately worry serious investors.
- Frequent auditor changes, especially in the 2–3 years before IPO, are treated by markets as a strong negative signal.
8. Tax, statutory and compliance gaps
- Pending GST/TDS/Income‑tax liabilities, unprovided interest/penalties, or reliance on aggressive tax positions can derail due diligence and impact valuation.
- Missing or incomplete audits, non‑filing or late filing of returns and MCA/ROC non‑compliances show poor discipline and can even cause the IPO to be rejected for lack of proper financial track record.
9. Related‑party and promoter transactions
- Large or opaque related‑party sales/purchases, loans to or from group entities, or significant guarantees, without clear commercial rationale, suggest tunnelling of value.
- Excessive remuneration, advances or diversion of funds to promoter‑linked entities will be scrutinized heavily by merchant bankers, regulators and institutional investors.
10. Leverage and repayment red flags
- Very high debt–equity, large short‑term borrowings used to fund long‑term assets, or frequent rolling over of working capital limits point to stressed finances.
- If a major chunk of proposed IPO proceeds is only to repay past debt rather than growth capex or working capital, it signals distress rather than opportunity.
11. Volatile or structurally weak margins
- Highly volatile gross or EBITDA margins versus peers, without clear input‑cost or business‑mix explanations, point to unstable economics or accounting games.
- Consistently lower margins than comparable listed SMEs suggest lack of pricing power, operational inefficiencies, or poor business quality.
12. Governance and reporting discipline
- Delayed or irregular financial reporting, poor MIS, absence of documented internal controls (ICFR), and lack of professional finance team are major red flags for an IPO candidate.
- Promoters pledging shares, off‑loading stakes before IPO, or facing significant undisclosed litigations over key assets or contracts damage investor confidence and can surface late in legal diligence.
How to use this as a promoter
- Run an internal “IPO readiness” review at least 6–8 quarters before the planned IPO date and clean up these issues proactively.
- Standardize policies, strengthen controls, and ensure at least three years of clean, consistent, audit‑ready financials before you go to the merchant banker for your SME IPO mandate.
FCA, CWM (AAFM-US), CBV, CIFRS, R-ID, B.COM (H), RV* (IBBI)
Practising Chartered Accountant in Delhi NCR Since 2011. He can be contacted at ankitgulgulia@gmail.com or +91-9811653975.