James Montier's C-Score and Professor Messod Beneish's M-Score are two of the most common quantitative fraud indicators used by investors. If you look through the warning signs from both indicators, one thing stands out: increase in days receivable.
I will discuss below some of the things you need to dig deeper into, if you find a stock that shows a sharp increase in days receivable.
Both debtor concentration and customer concentration need to be assessed. If a large percentage of accounts receivables is concentrated with a few debtors, the risk of non-payment on the receivables is higher. In addition, higher receivable days pose a bigger problem when the customers are loss-making and/or financially weak.
Increased receivable days could be a temporary problem, but large amounts of receivables overdue for a period of time exceeding the average receivable days of a company in particular face high risk of write-down and impairment. A trend analysis could be done to examine the trend of receivable days and the proportion of receivables overdue for more than 90 days.
At times, management may shift trade receivables to other receivables or other current assets in a bid to lower days receivables and "trick" the C-Score and M-Score. Pay attention if there is a sudden spike in other receivables or other current assets as a percentage of sales, compared with earlier financial periods.
Receivables from related parties should be analyzed separately, as the transactions between related parties might not be done on an arm's-length basis. The increase in receivables from related parties as a proportion of total receivables could increase the risk of fraudulent invoices and/or "channel stuffing" to sister companies.
Last but not least, there is also discretion over the calculation of days receivables such as whether average receivables over the period or ending balance of receivables should be used. For the purpose of detecting fraud, since practices like channel stuffing will be best detected using ending balance of receivables in the calculation of days receivable.
I will discuss below some of the things you need to dig deeper into, if you find a stock that shows a sharp increase in days receivable.
Both debtor concentration and customer concentration need to be assessed. If a large percentage of accounts receivables is concentrated with a few debtors, the risk of non-payment on the receivables is higher. In addition, higher receivable days pose a bigger problem when the customers are loss-making and/or financially weak.
Increased receivable days could be a temporary problem, but large amounts of receivables overdue for a period of time exceeding the average receivable days of a company in particular face high risk of write-down and impairment. A trend analysis could be done to examine the trend of receivable days and the proportion of receivables overdue for more than 90 days.
At times, management may shift trade receivables to other receivables or other current assets in a bid to lower days receivables and "trick" the C-Score and M-Score. Pay attention if there is a sudden spike in other receivables or other current assets as a percentage of sales, compared with earlier financial periods.
Receivables from related parties should be analyzed separately, as the transactions between related parties might not be done on an arm's-length basis. The increase in receivables from related parties as a proportion of total receivables could increase the risk of fraudulent invoices and/or "channel stuffing" to sister companies.
Last but not least, there is also discretion over the calculation of days receivables such as whether average receivables over the period or ending balance of receivables should be used. For the purpose of detecting fraud, since practices like channel stuffing will be best detected using ending balance of receivables in the calculation of days receivable.
