Why Is Rapid Growth an Accounting Red Flag?

A significant task in the accounting profession is auditing and fraud protection. Auditors will review a company's financial statements to ensure all information is accurate and valid, with information recorded according to specific accounting standards. Red flags---such as rapid growth in figures---will cause auditors to conduct a thorough review of accounting information.

Facts

Auditors typically find rapid growth by computing a trend analysis comparing current accounting information to a previous period. Calculating financial ratios for a benchmark analysis is also a measurement tool. These benchmarks allow for comparison to the industry standard. Extremely high ratios can indicate false information recorded into the accounting ledger.

Concern

Rapid growth is a concern because a company may be attempting to improve their profitability for shareholder investment or to obtain bank loans from a lender. False financial information leads external business owners to make incorrect investment decisions. The company can also mislead the general public, resulting in false confidence in the company or business industry.

Considerations

While rapid growth typically centers on sales accounts (which eventually leads to higher net income), other accounts can have rapid growth. Prepaid assets, inventory, cash, accounts receivable, accounts payable or other accounts can indicate rapid growth that may be a red flag.

References

• "Fraud Auditing and Forensic Accounting"; Tommie W. Singleton & Aaron J. Singleton; 2010