How to pick up mistakes or fraud on your financial statement or management report
/So here is my quick checklist on how to see if financial statements are incorrect or might contain fraud/misrepresentation:
- Unusually high revenues and low expenses when there isn’t a reason. For example, seasonal or compared to the industry or type of industry that the entity is in
- Growth in inventory or debtors that doesn’t match growth in sales or cash flows
- Improper capitalisation of expenses in excess of what is considered to be industry norms or reasonable
- A very high repairs and maintenance expense in the income statement
- Profit margins showing but no tax expense accounted for in the financial statements
- Turnover that is positive and growing but operating cash flow that appears to be decreasing
- Loans to executives or other parties that appear to be written off
- Gross margin or operating margins out of line with practice, previous periods or excessively low
- Excessive use of off-balance sheet entities based on relationships that aren’t standard within the industry
- Unusual increases in the book value of assets. This can include stock and trade debtors
- Deliberately complex or lack of disclosure notes that make it impossible to fully determine the nature of a transaction
- Prior year balances that do not agree with previous financials
- Balances that do not agree with third party confirmation letters or statements i.e. bank statements
