Want to make sure you don’t hire on with the next WorldCom? Hints on a company’s real health may be hidden in the financial filings public firms must submit to the government. But don’t worry: You don’t have to be a numbers whiz to spot the red flags.
Joseph Brazel, Ph.D., associate professor of accounting at North Carolina State University, matched the Securities and Exchange Commission filings of companies that committed fraud with similar firms that didn’t. He discovered those that cooked the books by exaggerating income often disclose non-financial information that provides an early warning of mischief or, at best, a shaky trajectory.
Search the 10-K for number of employees or patents, he says. "Have their patents grown with their revenue? If it hasn’t, you have to be a little cautious. When a company goes into fraud the revenue goes up but operational data is going flat or downhill."
For example, if the company reports increased revenue, check to make sure it’s reporting increases in these areas, too:
- Number of employees
- Number of patents
- Number of subsidiaries
- Web influence
- Number of distribution dealers
- Number of R&D employees
- Manufacturing space
- Number of production facilities
- Warehouse space
- Number of acquisitions
- Number of new products
- Number of countries doing business in
If the company reports higher income and earnings while these measures are declining, proceed with caution. Seek a second opinion from someone who can actually read sophisticated financial statements.
You can peruse Brazel’s research here.
— Dona DeZube