Rule #1 Finance Blog

With Investor Phil Town

QUESTION OF THE WEEK: WHEN A COMPANY RESTATES ITS FINANCIALS

Q:  If a company has had to restate its financial condition, is that a red flag? I looked up a company called Acme United Corp (ASE), and noticed that in 2002-2003, they had had to restate their financials. So, is this a red flag?

– Howard in Oklahoma

A:  Restating financials raises a red flag, but it can be taken down by some research into the issue.  Sometimes they didn't do anything wrong.  Companies sometimes have to restate financials when the SEC requires they change how they are accounting for something. 

For example, an education business like Phoenix Online might receive a year's worth of student fees in a lump sum.  Should they take in that income for the month when the student paid or should they spread it out over the whole year as they deliver the product to the student?  The SEC could require they do it the former way and then change their mind and make them do it the latter way… in which case the business would restate its earnings to reflect the new way of accounting.

Still, restated earnings do raise a red flag enough to require us to find out what the story is.  And in these cases just remember that if the business is not OBVIOUSLY a good deal then we don't do the deal.  So make sure you are very clear about what happened and are not just getting handed some hype job by their Investor Relations folks.

Now go play!- Phil Town