When analyzing a company’s financial statements, it’s important to remember that the company’s management may have manipulated the financial statements. The company may have engaged in aggressive revenue recognition or improperly capitalized expenses to inflate the company’s profit.
Thus, detecting whether a company has engaged in earnings management (or financial statement fraud) is a critical aspect of financial statement analysis; don’t just take the numbers as given. Remember that a lot of assumptions, estimates, and decisions led to the creation of those numbers, so they should be viewed with a degree of skepticism.
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