Warning Signs of Manipulation

This checklist of warning signs may just help you avoid your next Enron.

Income Statement Warning Signs

  1. Are receivables growing faster than revenues?
  2. Is operating cash flow significantly lower than accounting earnings?
  3. Are depreciation/amortisation periods longer than peer companies?
  4. Are there any unusual assets or unexplained large increases in assets such as inventory, relative to revenues?
  5. Were one-time or nonrecurring gains included in revenue?
  6. Were any gains or revenue based on revaluation of assets?
  7. Are there unusually high margins relative to peers?

Balance Sheet Warning Signs

  1. Is the company using operating leases to a greater extent than similar companies?
  2. Does the company have insufficient assets on its balance sheet to support reported operations and revenues – particularly relative to other similar companies?
  3. Does the company have significant assets that are subject to estimates or assumptions or where objective valuations are not available?
  4. Were any gains or revenue based on revaluation of assets, and what percentage of operating income comes from these activities?

Cash Flow Warning Signs

  1. Is the company delaying payment to suppliers and others, such as an increase in accounts payable?
  2. Look for factoring, sales of receivables, or other transactions to bring cash flow in early
  3. Any abnormal changes in capital expenditures?

Warning Signs of Manipulation – Final Words

The above was obtained from Asian Financial Statement Analysis by Tan Chin Hwee, which I am currently reading. I have removed some of the more technical points that appeared in the book. The warning signs indicate if a company’s management has been overly-aggressive in some of its accounting policies which warrants further investigation by the investor. It is by no means a death sentence that a company has committed fraud. Overall, the book is a good read and I would highly recommend it even though it is a little pricey – it retails for SGD143.3 at Kinokuniya.

Asian Financial Statement Analysis Warning Signs of Manipulation
Warning Signs of Manipulation