Fluent Essays

One step in assessing the quality of earnings is to look for red flags. An example of a red flag is a significant increase in accounts receivable without commensurate growth in sales (that is, accounts receivable turnover decreases). List and discuss at least five other red flags the astute analyst might look for, explain why each is a red flag, and identify where the analyst might find this information. Using your example, discuss how monitoring the financial results of a company’s competitors over time might help raise or explain red flags.Just do responce each posted # 1 yo 3 down below only.Posted 1 Red Flag One: Recording revenues before they are earned. This is a red flag because by doing this, revenues become misrepresented and, of course, boosted. Additionally, a company may have fraudulent sales by selling to a sister company with the intent of canceling the sale shortly after it is made. An analyst may find this information by not seeing any incurred expenses to match the realized revenue (Look for These Red Flags, n.d.). Red Flag Two: Delaying customer returns to a later quarter. This is a red flag because this makes revenues like higher than they actually are when in reality, a return has to be recorded sooner or later. An analyst might find this information by analyzing the revenues from previous quarters. By doing this, they may find inconsistencies. Red Flag Three: Misrepresenting expenses. A company could do this by manipulating inventory, not recording expenses whatsoever or not recording the full price of them. Analysts may find out if a company is doing this be reviewing expenses from previous periods and observing if whether or not there is a significant variance (Look for These Red Flags, n.d.). Red Flag Four: Keeping reserves of revenue from previous quarters. This is a red flag because it makes it look like the company is bringing in decent revenue when they are really just using reserves from previous periods. “Look for red flags in the earnings of past periods and management’s discussion of earnings” (Look for These Red Flags, n.d.). This is something analysts can do to try and spot red flags. Red Flag Five: Nonrecurring transactions. By looking into these transactions, analysts might discover something irregular and off the wall. By looking at the financial results of a company’s competitors, a company is better able to tell if they are doing everything that is in accordance with GAAP. Additionally, the observation of another company’s financial statements and find that there there are many red flags may explain why they seem to not be doing as good as their competitor. Posted 2 Good morning class, There are many red flags when it comes to earnings quality. The textbook lists several: Qualified audit report (Subramanyam, Wild, n.d., p. 113). This indicates that the auditor has determined that the financial statements are not in accordance with GAAP. Auditor resignation or a nonroutine auditor change (p. 113). This may indicate issues with the companys financial statements. Unexplained or frequent changes in accounting policies (p. 113). Such changes may indicate that the company is trying to hide something. Poor financial performance (p. 113). This increases the temptation to cheat. Use of mechanisms to circumvent accounting rules, such as operating leases and receivables securitization (p. 113). This practice suggests that the company may be trying to conceal something. All of these are indications of low earnings quality. One way of getting a better sense of how to interpret these red flags is to analyze how similar companies are performing. This would determine if the situation is unique to the company in question or a broader economic trend. Posted 3 Five red flags to watch out for in a company’s financial statement include: Increased inventory – An increase in inventory without an expansion or change in the company’s offerings could indicate that items are not selling or are at risk of becoming obsolete. An analyst would discover this potential red flag by reviewing the balance sheet and calculating inventory turnover (Najjar, 2019).Poor cash flow patterns – If a company is consistently experiencing low net cash flow, it may indicate poor collections efforts, lengthy payment schedules, or a low profit margin. An analyst would discover this potential red flag by reviewing the cash flow statement and identifying if the cause of the cash crunch is short term or long term (Najjar, 2019).Increase in non-operating income – A company with an increase in non-operating income from year to year may cause investors to become cautious or leery; the majority of a company’s revenue should be generated from normal operations of the business. An analyst would identify this potential red flag by reviewing the income statement from current and prior years and determining if the company is able to generate a profit from operating income alone (Najjar, 2019).More current liabilities than current assets – Consistently having more current liabilities than current assets could be a sign that a company is overleveraged. An analyst would identify this potential red flag by reviewing the balance sheet and calculating the current ratio (Ruther, 2018).Shrinking gross profit margin – A company that is experiencing a decrease in gross profit margin could indicate rising production costs, lower sales prices, or significant industry swings. An analyst would discover this potential red flag by reviewing the income statement and calculating gross profit margin and/or the operating ratio (Ruther, 2018). Investors often use ratios and other tools to evaluate companies and make comparisons between companies within an industry. Comparing the financial results of competitors can assist analysts in discovering if a potential red flag is normal for a specific industry or market. If a red flag is confirmed to only exist among one of the competitors, analysts are signaled to research the reason for the variance.