Question

Allen Software was a relatively new tech company led by aggressive founder Benjamin Allen. His strategy relied not so much on producing new products as using new equity capital to buy up other software companies. To keep attracting investors, Allen had to show year-to-year revenue growth. When his normal revenue streams stalled, he resorted to the tried-and-true “channel stuffing” technique. First, he improperly recorded shipments to his distributors as sales revenue; these shipments far exceeded the market demand for his products. Then he offered the distributors large payments to hold the excess inventory instead of returning it for a refund. Those payments were disguised as sales promotion expenses. He was able to show a considerable growth in revenues for two years running until one savvy investor group started asking questions. That led to a complaint filed with the SEC. The company is now in bankruptcy, and several criminal cases are pending.

1. What factor may have tipped off the investor group that something was wrong?
2. In what way would those investors have been harmed?
3. If Allen had attracted enough equity capital, do you think he would have been able to conceal the scheme?

Answer 1

1 In addition to the sales revenue growth in. income Statement , the investors could analyze Some key ratios to evaluate the profitability for company. A such as return on net sales, return on total Assets, return on common Stock holder os Equity and earnings per share of common stock : Since company A recorded a high amount sales promotion expenses to cover the payment for distributor "holding the product the net income of Company A decreased through years even with revedue. 2) The investors were cheated by the fraud. They could make wrong investment deusion based on sale Sale revenue growth and may lose their investment money Someday. 3) Mr. A can't conceal the fraud even if he had Enough Equity capital. Because with time passed the company Ais financial analysis ratio would reveal the truth of those fakes sales revenue growths. Some Savvy investors also rould find problems behind the false growth.