The Analyst’s Course · Forensic Accounting
The 12-Item Earnings-Quality Checklist
Revenue-side flags (1–4)
1. Receivables growing faster than sales for 2+ years (DSRI rising) — channel stuffing or hollow sales. 2. Revenue growth decelerating while receivables accelerate (the crossover). 3. A large new "other revenue" or "licensing" line with weak explanation. 4. Distributor or related-party concentration in revenue or receivables (footnotes). In the panel: Beneish DSRI and SGAI cards plus the revenue trend in the DuPont view.
Expense and asset flags (5–8)
5. Inventory outgrowing COGS (future markdowns or demand already fading). 6. Capitalized costs ballooning — software development, contract acquisition costs (AQI rising). 7. D&A falling while capex rises (DEPI falling — assets kept alive longer than peers). 8. Big gaps between EBITDA and CFO persisting (somebody is calling real costs "non-recurring"). In the panel: AQI, DEPI, TATA and the cash-conversion gauge.
Cash and structure flags (9–12)
9. CFO < NI three years running (the core quality break). 10. Free cash conversion weak while "adjusted" earnings metrics shine (the adjusted-vs-GAAP wedge). 11. Rising leverage into a falling-margin period (LVGI rising while GMI rises — motive plus means). 12. Auditor changes, urgent 8-K restatements, or CFO turnover mid-story (governance tells). In the panel: Z-zone, LVGI, and the flags strip aggregate the quantitative ones; 12 is yours to check by hand.
WorldCom, 2002 — one flag, $3.8B
WorldCom capitalized $3.8B of ordinary line costs as capital expenditure — moving real operating expense below the EBITDA line into assets to be depreciated over decades. On a checklist: capex ballooned (flag 6), D&A followed it up (a distorted DEPI), CFO and NI both flattered but FCF quietly collapsed once the fake "assets" stopped being worth anything. One honest read of the capex-to-depreciation ratio against industry peers ends the story in one sentence. The full case file is lesson 8.
What you'll practise
Inventory growing persistently faster than COGS suggests…
3 graded checkpoints · certification exam at the end of the track
Sources
Altman (1968); Beneish (1999); Sloan (1996); company 10-K filings via SEC EDGAR
Learn content is for education only — not individualized financial advice, a recommendation, or a solicitation to buy or sell any security. Options involve substantial risk. Examples are simplified and historical patterns never guarantee future results.