Accounting Red Flags
Arche reads financial statements the way a claims adjuster reads accident reports: respectfully, and alert for stories. Accounting is a language, and like any language it can inform or obfuscate. The following patterns deserve questions before they deserve trust.
EBITDA: depreciation still has a cost
The problem isn’t the arithmetic; it’s the invitation to pretend that depreciation — the very real consumption of very real assets — isn’t a cost. A trucking company’s fleet wears out mile by mile. Excluding that from “earnings” flatters exactly the businesses that deserve it least: the capital-hungry ones. You will not find EBITDA anywhere in this site’s framework. Where leverage needs measuring we use interest coverage against operating income, and where cash generation needs measuring we use owner earnings — depreciation’s honest cousin, which includes the cost of staying in business.
The serial “one-time” charge
A restructuring charge is information. A restructuring charge every second year is a business model. Companies that routinely bundle costs into “special items” are training investors to ignore real expenses. It is like a golfer banking bad holes in advance to smooth the scorecard. Our Financial Fortress pillar docks companies whose “nonrecurring” items recur, and the research reports are instructed to say so in plain language.
Stock compensation: an expense wearing a costume
Stock pay is compensation, and compensation is an economic expense. Because it is a non-cash add-back, cash-flow statements quietly launder it into “cash generation,” and adjusted-earnings press releases vanish it entirely. But the dilution is arithmetic: what the company didn’t pay in cash, it paid in your ownership percentage. We subtract stock compensation from owner earnings and score SBC above 10% of operating cash flow as a red flag.
Other entries in the phrasebook
- Pension optimism. An assumed return set high makes today’s earnings bloom and tomorrow’s shortfall someone else’s disclosure. Compare the assumption with market yields and the plan’s actual long-run experience.
- Receivables outrunning revenue. Sales booked faster than customers pay is growth on layaway.
- Goodwill mountains after serial deals. Goodwill itself is neutral; goodwill plus declining returns on capital is a confession of overpaying.
- Adjusted-earnings inflation. The wider the gap between “adjusted” and GAAP, year after year, the more the adjective is doing the earning.
The disposition to bring
None of these flags convicts by itself; each is a question the filings owe you an answer to. The pattern to fear is vagueness. Management teams comfortable with their numbers explain them simply and reconcile adjusted measures to the underlying economics. When the explanation gets complicated, the $1 test and the owner-earnings bridge on these pages are where the complexity usually surfaces.