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How revenues can be rigged
Channel Stuffing
• Increasing % of Traded Goods
High % of receivables over 180 days
• % Growth in receivables vs % growth in sales
• % Growth in inventory vs % growth in sales
• Declining CFO/EBITDA Ratio
• Amount of Receivables going bad
We discussed these with examples of Parag Milk and Solara Active Pharma Science
After that we discussed the case studies for change in working capital. Working capital is the capital
that is required for the daily operations of the business.
Net Working Capital = Trade Receivables + Inventory - Trade Payables
Improving Net Working Capital cycle denotes higher cash flow
Declining Net Working Capital cycle denotes lesser cash flow
We studied the case studies on the same with the example of Caplin Point, where trade receivable
days & inventory days are growing at a very high pace. We also saw the financials of its subsidiary
companies where they don't have any employees and also haven't paid any audit fees.
After that we understand the capitalization of pre operating expenses, Certain costs like Pre-
operating expenditure, capital expenditure, interest cost, R&D and Intangible assets can be
capitalised by the management as it is allowed by the accounting standards.
Capitalization of R&D cost is an aggressive accounting as we don't know whether it will be fruitful or
not in future so IMO it should not be capitalized, we saw the examples of the same where good
example have companies like AVT Natural, Laurus Labs and in bad examples we have Biocon and
HEG.
Post these we also understand the meaning of related party transactions and various case studies on
the same. Related Party Transactions means the transactions entered by the company with the
promoters/managers, their family members, and the companies/entities owned by them. High RPT
must raise doubts amongst investors about the willingness or intent of the management.
Different types of RPTS:
1. Company giving loans to promoters / subsidiary
2. Company buying Raw Material from promoters / relative owned companies.
3. Company selling goods promoters / relative owned companies.
4. Company taking loans from its promoters at high interest rates
5. Buying equity from promoters in a subsidiary company
6. Buying or selling assets to related party
7. Having entities in the same line of business
We covered the following case studies on the same:

1. Gar ware Technical Fibres paying extraordinary processing charges to subsidiary
2. In Spandana Sphoorty case high related party transactions with directors having entities in
the same line of business and high commission to directors
3. High Related party transactions in Glenmark life sciences and reasons for its lower valuations
4. We also saw the examples of many MNCs having unlisted subsidiaries in same line of
business like Nestle, Abbott, Phizer, AstraZeneca, Sanofi, P&G, Colgate, Cummins Then in the
last portion of our discussion we saw the case studies on churn in Key Managerial Personnel,
KMP are the persons who are incharge of maintaining the operations of the company.
includes personnel like CEO, CFO, Company Secretary, Whole Time Director. There is a simple
rule: If there is too much churn in KMP it is better to get out of the company. We then
understand this with examples like Ujjivan SFB, PI Industries, RBL Bank, Yes Bank, Axis Bank,
Spandana Sphoorty.
Forensic checklist:
 Debt to Equity < 0.7 Misallocation of capital - check past track record of investing in non-
core business
 Has the company shared the wealth with the shareholders historically? - Check Dividend
Payout & Share Buyback history
 What is the EBITDA/CFO & CFO/PAT for the last 1, 3 & 5 years? - Higher the better
 Does the promoter have private entities in the same line of business? • How high are the
Related Party Transactions compared to sales?
 Is there any contingent liability that threatens survival? (Extremely high tax disputes in
Inox's leisures case)
 What is the auditor's opinion & are there any red flags in the auditor's opinion (E.g:
Shankara Building Products)
 What is the Gross Working Capital when compared to the industry? (GWC= Receivable
Days + Inventory Days)
 How many times has the CFO changed in the last 5 years?
 What percentage is the goodwill as a percentage of total assets? (Is the goodwill acquired
due to acquisitions in the non-c on-core areas)

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How revenues can be rigged

• Increasing % of Traded Goods

High % of receivables over 180 days

• % Growth in receivables vs % growth in sales

• % Growth in inventory vs % growth in sales

• Declining CFO/EBITDA Ratio

• Amount of Receivables going bad

Net Working Capital = Trade Receivables + Inventory - Trade Payables

Improving Net Working Capital cycle denotes higher cash flow

Declining Net Working Capital cycle denotes lesser cash flow

Different types of RPTS:

1. Company giving loans to promoters / subsidiary

2. Company buying Raw Material from promoters / relative owned companies.

3. Company selling goods promoters / relative owned companies.

4. Company taking loans from its promoters at high interest rates

5. Buying equity from promoters in a subsidiary company

6. Buying or selling assets to related party

7. Having entities in the same line of business

We covered the following case studies on the same:

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