Accounting Red Flags

Aggressive accounting is not fraud — but it is the frontier between reporting and misrepresentation. Recognizing revenue earlier than standard practice allows, capitalizing expenses that should be expensed, or classifying recurring costs as "one-time" to inflate EBITDA are all legal accounting choices that distort economic reality. Identifying these patterns is not about catching fraud. It is about understanding the gap between the presentation and the reality.

1. Revenue Recognition Patterns Compare recognized revenue to cash collected. If recognized revenue consistently exceeds cash receipts by more than one DSO cycle, revenue may be accelerated. Check for lump-sum recognition of multi-year contracts, recognition before delivery milestones, or channel-stuffing patterns where revenue spikes at period-end and returns or credits spike in the following period.
2. Expense Capitalization Review capitalized software development, customer acquisition costs, and any balance sheet item that grew faster than revenue. Companies capitalize expenses to move them off the P&L and inflate EBITDA. The test: would this expense occur again next year? If yes, it is operating expense, not a capitalizable asset. Aggressive capitalization inflates both the balance sheet and the income statement simultaneously.
3. Related-Party Transactions Identify any transactions between the company and entities owned or controlled by the founder, their family, or key employees. Common patterns: above-market rent to a founder-owned property, consulting fees to a founder's other company, vendor contracts with family members. None are automatically problematic — but all must be evaluated at arm's length terms.