Home Solutions of America Admits Problems, Delays Quarterly Report

See the press release at Yahoo. The stock of HSOA [[hsoa]] is down big on the announcement. The report is delayed because its auditors need more time to investigate related-party transactions. My bet is that some of them turn out to be sham transactions and much of HSOA’s so-called earnings go up in smoke. If that is the case it’s lender could call its line of credit (which is secured by receivables, some of which are from related-party transactions), forcing HSOA into bankruptcy.

This is another good example of why self-dealing is bad and why cash flow trumps earnings. The classic way to commit accounting fraud to pump up earnings is to make sham deals with pliant customers or related parties. The revenues are accrued, going into accounts receivable, and earnings are pumped up, but no cash is ever paid and the ‘earnings’ turn out to be non-existent. That is why I try to steer away from companies that have too many receivables and greater earnings than cash flows. In these cases, even if there is no fraud, the receivables may turn out to be noncollectable and the earnings are never followed by cash flow. So, even if there is no fraud at HSOA, shareholders will likely continue to be disappointed by the lack of cash the company can actually collect.

Disclosure: I have no position in HSOA, long or short. My disclosure policy committed accounting fraud back in 1984 but has since paid its debt to society and now speaks to corporations about the dangers of insider self-dealing.