Lesson 7 of 7 · 15 min
Warning signs and how to detect manipulation
Manipulation leaves tracks in revenue, receivables, inventory, capitalisation, cash flow and disclosures; no single sign proves anything, but several together should make an analyst cautious or walk away.
In short
- Manipulation usually means biased revenue or expense recognition, by timing (for example capitalising costs) or location (for example losses in OCI or equity instead of profit or loss).
- Revenue: aggressive policies (recognition on shipment, bill-and-hold, barter, rebates, multiple deliverables), growth out of line with peers, receivables growing faster than revenue, rising DSO or falling receivables turnover, declining asset turnover.
- Inventory: inventory growing faster than sales or peers, falling inventory turnover (possible unrecognised obsolescence), LIFO liquidations.
- Capitalisation out of line with industry; CFO/net income below 1 or falling.
- Other signs: lenient depreciation, fourth-quarter surprises, related-party transactions, non-operating or one-time items in revenue, serial 'non-recurring' charges, margins well above peers.
- Context: a young company with a perfect growth record, minimal disclosure, earnings fixation, an aggressive culture, CEO-chair duality, a weak audit committee, big-bath restructurings and serial acquisitions.
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