Financial Fraud in Cash and Accounts Receivable

BS - Stanley SelfBy Stanley W. Self
Full-Time Faculty, School of Business

Financial Fraud in Business Acquisition 

As discussed in the related December article, “Precautions to Help Avoid Financial and Credit Card Fraud,” financial fraud takes many forms. 

Some types are less obvious, and the effect on consumers is not directly apparent.

Case Description

Depending upon the industry and complexity of an acquisition, a variety of frauds are possible. The specific acquisition involved the purchase of a large truck stop. The subject is large in terms of both business volume and physical presence (about 100 acres). A number of separate financial frauds were discovered during the due diligence process. The only example presented will include cash and accounts receivable (AR) fraud. 

Auditing standards require audits to be performed by professionals experienced in the industry. Understanding all aspects of a business operation is critical to an audit, due diligence, and financial fraud investigation.    

Becoming Educated 

Reading trade journals dedicated specifically to an industry may improve familiarity with standard terminology and procedures. Becoming acquainted with peers and networking can be invaluable methods for generating information. 

Understanding metrics used to evaluate performance of any industry is vital to any due diligence process. Many sources of information are available; one valuable tactic used to build understanding of the truck stop business would be to conduct informal interviews with personnel in different truck stops operating in the region.

Camouflage—Learning to Blend In  

Although business attire is usually appropriate, a financial researcher may need to modify his or her appearance to be received positively in some situations. Wearing clothing that resembles a truck driver’s attire into a truck stop may offer more opportunity for open conversation than wearing the type of clothing that people might associate with the IRS. 

Another effective tool is to allow information to flow freely without making the research objective obvious. Maintaining an informal demeanor may facilitate free-flowing information. 

Understanding the metrics of each component of truck stop operations would be an essential first step for investigating financial accounting fraud in that environment. Financial analysis of industry standards applies to due diligence. 

Cash and Receivables  

One significant component of truck stop operations involves AR, including: in-house accounts, different fuel and national credit card clearing-house operations. There are many layers of sales, discounts, payments schedules, and multiple complex banking relationships. Analysis of the cash cycle for previous periods as compared to the cash cycle for the period leading up to the acquisition revealed an anomaly. Significant analysis was needed to unravel the cash account, billing statement, and remittance discrepancies. 

By analyzing each of many bank statements, a point of precise reconciliation was determined. Then, by progressive reconciliation through all periods up to the date of acquisition, a $53,000 discrepancy was discovered. Subsequent analysis revealed $53,000 had been posted to the cash accounts but had not been posted to the individual customer AR. That inflated the assets because the same $53,000 was reflected twice in current assets (once as cash, and again as an open AR). 

To unravel the discrepancy, a search of all AR subsidiary accounts was necessary. Analysis proved that those amounts had been credited to cash sales. This finding corresponded to an unexplained increase in the profit margin for the period.   

Conclusion 

Financial statement analysis must assemble facts. Financial analysis is a critical component of the process of uncovering financial fraud. Equally important would be industry-specific knowledge. Interview skills were invaluable. But perhaps the most important tool for protecting financial heath is old fashioned common sense.  

Interested in this career? Check out Kaplan University's Business resources here.

Stanley Self is a full-time faculty member at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.



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