Company management can manipulate financial statements, and a perceptive analyst can use his or her understanding of financial statements to detect misrepresentations.
For example, companies may improperly record costs as assets rather than as expenses and amortize the assets over future periods. The goal is to impress shareholders and bankers with higher profits. Consider advertising expenses, which should be charged against income immediately. Certain companies, particularly those selling memberships to customers (e.g., health clubs and Internet access providers), aggressively capitalize these costs and spread them over several periods.
Companies may amortize long-term assets too slowly. Slow depreciation or amortization keeps assets on the balance sheet longer, resulting in a higher net worth. With slow amortization, expenses are lower and profits are higher.