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Sometimes you can anticipate results before they happen with forensic acct


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Sometimes you can anticipate fundamental results before they happen with forensic accounting


This wont be 100% predictive but if you are interested in learning more about forensic accounting and accounting red flags to watch out for to learn here is a case study.  I have generally found even most experienced analysts have very weak forensic accounting skills so it is not something simple.  But it can keep you out of some high risk situations and blow ups. 


I was looking at a company this am and saw the 2015 cash flow statement and organic growth and a lot of forensic accounting red flags went up immediately. 


You can download the 2015 annual here:  http://www.essentraplc.com/investors/company-information/financial-summary


Take a good look at it and see if you spot anything that might be an issue before you read on.  Except for link, I have left company name off post.







Here is what I noticed:

1. Organic growth (like-for-like) was ~0.7%.  Essentially flat.

2. And on to the cash flow statement:  Inventory increase (14.6m) which is a 17% rise over the 12/31/14 balance.  A/R increase (51.2m) which is a 31% rise over the 12/31/14 balance. 


Notice how Inventory and A/R are rising much faster than organic growth.  31% A/R vs ~0.7% for organic sales growth.  These can indicate either serious business issues or accounting shenanigans companies may be playing to use the balance sheet to boost earnings. 



What about the provision for impaired receivables (or provision for doubtful accounts in the US )?  That is one of the easiest accounts to reverse if mgmt wants to boost income.  See note 18.  Although the company wrote off 1.5m of A/R in 2015 it recorded an income of 2.6m (not an expense) from a net reversal of it’s A/R provision.  (2.9m release- .3m impairment = 2.6m).  A realistic expense for impaired A/R should have been ~1.5m for 2015.  That is a 4.1m difference.


What happened subsequently? 


Fundamental results have stunk and the old CEO is gone. 

Interestingly enough the CEO was a CFO of a major company before.  Hmm



Anyone that is interested in learning more about the skill should read Howard Schilit’s Financial Shenanigans book and look at a ton of historical case studies.  The case studies will be highly instructive.


*The acquisition done in 2015 would have increased the balance sheet accounts but probably not so much of an effect organically on the cash flow statement. 


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