(from Value Walk) By paying close attention to matters including capitalized expenses and accrual ratios, leaders can flag accounting irregularities early, potentially preventing outright fraud. Deutsche Bank analyst Luke Templeman recommends paying attention to the following:
- Ratio of accounts receivable as a proportion of sales. If this metric is increasing, the entity may not be getting cash for the sales it reports.
- Even distribution of numbers as the first digit in financial statements. In something known as "Benford's law," there are mathematical reasons for the number one to disproportionately be the first number in revenues, assets and other financial numbers.
- Tax provisions on the balance sheet. This can be a good place to hide money that's being siphoned out. One red flag is a shrinking ratio between sales and taxes payable and receivable.
- Capitalized assets as a proportion of total assets. Be alert to changes in this ratio over time.
- Higher paper profits than other similar organizations. Paying close attention to accrual ratios can show whether an entity is generating actual cash or only reporting paper profits.
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