Warning Signs of Manipulation
This checklist of warning signs may just help you avoid your next Enron.
Income Statement Warning Signs
- Are receivables growing faster than revenues?
- Is operating cash flow significantly lower than accounting earnings?
- Are depreciation/amortisation periods longer than peer companies?
- Are there any unusual assets or unexplained large increases in assets such as inventory, relative to revenues?
- Were one-time or nonrecurring gains included in revenue?
- Were any gains or revenue based on revaluation of assets?
- Are there unusually high margins relative to peers?
Balance Sheet Warning Signs
- Is the company using operating leases to a greater extent than similar companies?
- Does the company have insufficient assets on its balance sheet to support reported operations and revenues – particularly relative to other similar companies?
- Does the company have significant assets that are subject to estimates or assumptions or where objective valuations are not available?
- Were any gains or revenue based on revaluation of assets, and what percentage of operating income comes from these activities?
Cash Flow Warning Signs
- Is the company delaying payment to suppliers and others, such as an increase in accounts payable?
- Look for factoring, sales of receivables, or other transactions to bring cash flow in early
- 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.
