How financial statement fraud can impact your business

Rebekah Smith, CFFA, CPA, CVA, Director of Financial Advisory Services, GBQ Consulting LLC

When preparing your company’s financial statement, it may seem all too easy to lie about your numbers to make your company seem more successful — especially in this tough economy. Whether you’re tempted to manipulate your statements to hit a personal performance goal, receive a bonus, keep the bank from calling a loan, or to inflate a purchase price, it’s all considered financial statement fraud.

“Financial statement frauds impact closely held companies as well,” says Rebekah Smith, CFFA, CPA, CVA, director of financial advisory services with GBQ Consulting LLC. “They can be a less obvious fraud, such as deferring revenues or expense in a different time period to give the appearance of consistent earnings or growth. Or it can be a more complex scheme where the business overstates revenues by recording false revenues.”

Smart Business spoke with Smith about the signs that point to financial statement fraud and how to stop it from happening in your company.

How many businesses are impacted by fraud?

The Association of Certified Fraud Examiners reports on fraud trends every other year. In the 2010 report, only 5 percent of fraud cases they studied were financial statement fraud. However, financial statement fraud was responsible for the largest losses, representing 68 percent of the dollars studied. When financial statement fraud does occur, it generally has a significant impact on a business.

What are some signs to look for if you think someone is committing financial statement fraud?

The signs vary and you must consider the motive of the person who is most likely to commit the fraud. For example, in a situation where the person would benefit from the financials appearing to be better than actual performance, key indicators could potentially include:

■ Unexplained revenue or sales growth without a corresponding increase in cash flow.

■ Increased sales and an unexplained increased days outstanding sales (the measurement for the number of days it takes to convert revenues to cash).

■ A sudden, unexplained increase in revenue without a corresponding increase in expected expenses.

On the other hand, consider someone who is trying to buy out a partner or is going through a divorce; his or her motives might be different and thus the indicators would be different as well:

■ An unexplained decline in the business while the rest of the industry is still performing.

■ A sudden unexplained increase in expenses without a corresponding increase in revenue.

Who typically commits financial statement fraud?

Unfortunately, the profile of a person who commits financial statement fraud tends to be a trusted employee of the company who generally has long tenure and is part of the management team. Perpetrating a fraud requires the ability to circumvent internal controls and trust is an element that helps a fraudster enact his or her scheme. Individuals that commit frauds are generally financially minded and clever individuals. The complexity of the scheme sometimes requires that the individual be well versed in financial and operational matters to understand how to successfully circumvent internal controls.

What steps do you need to take if financial statement fraud has been committed?

It is important to secure any evidence that might be susceptible to being destroyed. Too many times the first instinct is to confront the individual who allegedly perpetrated the fraud and, next thing you know, documents are missing. Once documents and evidence is sure, you should contact your lawyer and, if necessary, ask for assistance from a forensic accountant. Pulling together a qualified, experienced team to help through the process will make prosecution and recovery easier.

What items can you put in place to prevent financial statement fraud from happening in your company?

Reviewing your company’s internal controls and policies and procedures is first and foremost. Sometimes due to the size of the organization or financial constraints, you cannot achieve perfect segregation of duties amongst your management and accounting and financial staff. However, a careful study of your policies can reveal the areas where you are most vulnerable and your internal controls can be designed to minimize the risk of a fraud.

Do you think financial statement fraud is on the rise or decline?

Unfortunately, coming out of tough economic times, the trend will likely be an increase in the number of frauds that are discovered in the next few years. Businesses faced incredible pressure to perform over the last two years and financial statement fraud takes time to uncover. On average, financial statement fraud goes on for 27 months before it’s uncovered. So it may be 2012 or 2013 before some 2009 and 2010 frauds are uncovered.

REBEKAH SMITH, CFFA, CPA, CVA, is the director of financial advisory services at GBQ Consulting LLC. Reach her at (614) 947-5300 or [email protected]