Understand the three key financial indicators, avoid pitfalls three months in advance

Have you ever had this kind of experience—today you open your stock trading app, and a stock suddenly plunges 8%? You frantically read the news, scroll through stock forums, ask “big Vs,” trying to figure out what exactly happened.

In the end, you may only find a single line like: “The company’s performance fell short of expectations” or “Main capital flowed out.” Then you wonder: Why am I always the last one to know the real reason?

Actually, the real cause has nothing to do with today’s news at all.

Operating Cash Flow Exceeds Net Profit

What is operating cash flow? Simply put, it’s the cash the company truly recovers from doing business. As for net profit, it’s “paper wealth”—the kind of prosperity on paper. If customers sign IOUs, that’s counted as revenue; depreciation is deducted, but no cash is spent.

Why must cash flow be greater than net profit?

Because only cash is the lifeblood of a business. If a company’s income statement looks great—earning 100 million yuan a year in profit—but its operating cash flow is only 20 million yuan, or even negative, what does that mean? It means it hasn’t actually received the money for what it sold, or all the earnings have turned into inventory and accounts receivable.

When this goes on long-term, the company falls into a strange loop of “making money but no cash comes in”: book profits keep rising, while cash on hand keeps shrinking. By the time it needs to repay debts, pay wages, or purchase raw materials, it can only borrow money or issue more shares—eventually breaking the capital chain.

Accounts Receivable Growth Rate Cannot Exceed Revenue Growth Rate

What are accounts receivable? They’re the IOUs on the books—goods have been sold, but the customer hasn’t paid, so the IOU stays as a balance.

Why is this indicator important? If a company’s revenue grows by 30%, it looks very good. But if accounts receivable grow by 60%, what does that mean? It means, to boost performance, the company is aggressively loosening credit: letting goods go before payment, extending the payment terms, and even pushing inventory onto distributors.

This kind of growth is fake, because the money was never actually collected.

Even scarier is that these IOUs could turn into bad debts at any time—if customers go bankrupt or refuse to pay, the company must recognize losses in one go, wiping out several years’ worth of profit.

And the more accounts receivable pile up, the more it means the company has almost no pricing power over downstream customers, putting it in a passive position.

Gross Profit Margin Is Far Higher Than Peers, Yet There’s No Reasonable Explanation

Is having a high gross profit margin necessarily a good thing? Not necessarily.

Companies like Moutai(600519), with gross margins above 90%, are like that because of brand premium, scarcity, and a long-term moat built up over time. But if you’re a company making ordinary products—where the industry average gross margin is 20%—and you manage to reach 60%, that’s a bit dangerous.

Why is an abnormally high gross margin a dangerous signal? In a market with full competition, extremely high gross margins will definitely attract competitors. If a company has been far higher than peers for the long term and can’t explain the reasons clearly (for example, an exclusive patent, technical barriers, special licenses, or resource monopolies), then it’s highly likely there are financial irregularities.

Common tactics include: inflating revenue (counting goods that haven’t been sold as sales), under-recording costs (hiding expenses elsewhere), and using related-party transactions to boost profits. These actions will eventually be exposed. Once regulators issue inquiries or an audit finds problems, the stock price can plunge sharply.

In short, remember these three rules:

Operating cash flow > Net profit (check whether the profits are real)

Accounts receivable growth ≤ Revenue growth (check the quality of revenue)

Gross profit margin matches peers; exceptions only when there are barriers (to prevent financial fraud)