One of the common themes that we've seen when management manipulates estimates is that we can often spot the signs of this in the calculation of operating cash flows in the cash flow statement. This is because these estimates result in non-cash earnings, so hopefully you can see that the cash flow statement is an incredibly powerful tool in identifying bias in management estimates.

On this slide, we have an example of a cashflow statement extract for a company, and we're asked here to identify what concerns we have about the information shown in this cashflow statement. So please now pause this recording and spend 30 seconds thinking about which adjustments shown here could provide evidence of management bias. Once you've done this, you can resume the recording before we even look at the individual adjustments. One issue immediately stands out in this table, although operating cash flows are higher than net income, remember that the operating cash flows are after adding back depreciation and amortization. If we were instead to compare operating cash flows to EBITDA, which is a very common way of calculating cash conversion, it's likely that we would see a worryingly low cash conversion figure for this company, and this would raise red flags for us regarding management's use of estimates. Now, let's look at the individual adjustments. Firstly, contract impairment losses. The contract impairment losses provide evidence that the company has a poor track record of estimating contract costs and therefore has accelerated its revenue and profit recognition on these contracts. Secondly, increases in receivables. There is an unusually large increase in receivables in 2018, and it's important to remember that this line would include accrued income balances. So this provides evidence that the management have used aggressive revenue recognition in its long-term contracts, particularly when aligned with the information above on contract impairments. Ideally, this would prompt further investigation of the footnotes on accrued income and contract balances to see if these disclosures support this finding. Next, the decrease in provisions. This adjustment suggests either a large utilization of provisions or that the provisions are being released to earnings, and this would provide an artificial boost to profits. Ideally, this should prompt us to dive into the footnotes on provisions to better understand what is happening to the provisions balance. Finally, the acquisition at the end of 2018. Now this is a bit of a red herring as it won't have much of an impact on the 2018 earnings numbers since the acquisition took place towards the end of the year. However, it does provide a risk for future earnings and should prompt us to analyze the footnotes related to the acquisition to see if there is evidence of aggressive fair value adjustments that is step ups and step downs, or aggressive provisions for contingent consideration.