These red flags include the following:
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Aggressive revenue recognition practices, such as recognizing revenue in earlier periods than when the product was sold or the service was delivered
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Unusually high revenues and low expenses at period end that can't be attributed to seasonality
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Growth in inventory that doesn't match growth in sales
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Improper capitalization of expenses in excess of industry norms
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Reported earnings that are positive and growing but operating cash flow that's declining
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Growth in revenues that's far greater than growth in other companies in the same industry or peer group
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Gross margin or operating margins out of line with peer companies
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Extensive use of off–balance sheet entities based on relationships that aren't normal in the industry
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Sudden increases in gross margin or cash flow as compared with the company's prior performance and with industry averages
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Unusual increases in the book value of assets, such as inventory and receivables
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Disclosure notes so complex that it's impossible to determine the actual nature of a particular transaction
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Invoices that go unrecorded in the company's financial books
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Loans to executives or other related parties that are written off
A business that engages in such fraudulent practices stands to lose a tremendous amount of money when penalties and fines, legal costs, the loss of investor confidence, and a tarnished reputation are taken into account.
