Friday, May 15, 2009

Accounting Red Flags - Anomalies to watch out

Few points:

1) Periodic Earnings rate increase should be commensurate with cash flow increase - If earnings increase but not cash flow, there is a possibility that company may be selling assets/investments to cover losses.

2) Analyst can read the audit report to see if the auditor has a qualified, adverse of disclaimer of opinion.

3) Inventory turnover ratio keeps decreasing though sales is consistent. - Management could be piling up inventories on credit to boost the cash flow ( tax advantage)

4) Frequent changes in accounting policies.( like change from FIFO to LIFO without concrete reasoning). This should be viewed in terms of timing.

Good link:

Derivatives Unleashed by Professor Michael Greenberg

On 05/15/2009, Michael Greenberg, Professor gave a good explanation of the derivatives.
My understanding: Derivatives are the value derived from the value of the underlying asset. If the underlying asset's value goes down, depending on the stand that the derivative took, the derivative value goes up or down.
Eg: If I own a house and run the risk of fire on the house, I get a fire insurance. When my house goes on fire, I can claim the loss through my insurance which is straight forward. If three other people buy the same insurance on my house, they are really indirectly betting that my house will go on fire and they make money if it does.While me taking the insurance makes economic sense from a risk perspective, the other bets turn the derivative market into a frankenstein monster cassino.

Currently Congress is contemplating on regulation similar to the Pecora investigation in the link below

From an accounting point of view, there is no contingent obligation through any unrealized loss booked as well which hides these exposures until they realize.

CSPAN also shared the illustration of Derivatives published in The Washington Post -