© D.L. Crumbley
Do the Sniff Test – This one’s subjective, but it’s powerful. Essentially, if something looks wrong, and management can’t provide a convincing explanation, it probably is wrong. Trust your gut.
Remember that Cash is Always King – Does accounting gobbledygook make your head spin? Fear not – there is one very simple thing you can do: Keep an eye on cash flow. Over time, increases in a company’s cash flow from operations should roughly track increases in net income.
If you see cash from operations decline even as net income keeps marching upward – or if cash from operations increases much more slowly than net income – watch out.
Source: Pat Dorsey, “Five Tips for Spotting Financial Fakery,” Yahoo! Finance, February 11, 2004.