How to Avoid Financial Statement Manipulation in Your Business

In today’s business world, financial statements are under constant pressure from both regulators and investors. While some may carp about the complexities of financial statements, the fact is that a well-drafted financial statement can provide a valuable view into the financial health of a business. However, the financial statements of a business can also be the target of unscrupulous investors and management teams who want to see the company’s cash flow converted into profits.

If there is sufficient capital available, a company can easily secure the financing necessary to execute its strategic plan. However, if there is a shortage of cash, the company may need to restrict its business operations in order to meet its cash flow obligations. That’s where financial statement manipulation comes into play.

Financial statement manipulation is the act of intentionally falsifying or tampering with a company’s financial statements in order to hide a business’s financial condition or performance.

The financial statements of a business may be manipulated in a variety of different ways, including: - omitting or omitting information that would reveal a company’s financial condition or performance - inflating or reducing the value of assets or expenses to make the financial statement look more profitable - concealing the true extent of a company’s indebtedness or its financial leverage - delaying the disclosure of important operational data or changes to the financial statements in order to mask an unviable financial condition.

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What is Financial Statement Manipulation?

Financial statement manipulation is the act of deliberately falsifying or tampering with a company’s financial statements in order to hide a business’s financial condition or performance.

 

What are the Advantages and Disadvantages of Financial Statement Manipulation?

Financial statement manipulation has many advantages and disadvantages, which depend on the mentality of the person engaging in the practice. In general, though, financial statement tampering is done for a few reasons. The most common reason is to increase a company’s listed financial ratios. This can be done by omitting information that would reveal a company’s financial condition or performance or by inflating or reducing the value of assets or expenses to make the financial statement look more profitable.

The lessening of a company’s cash flow may also be a result of financial statement manipulation. When a company artificially lowers its reported cash flow from operations to secure a financing deal, it is reducing its cash at its most valuable asset, which is its disposal. Additionally, financial statement manipulation can also occur when a company wants to delay the disclosure of important operational data or changes to the financial statements in order to mask an unviable financial condition or results.

 

Types Of Financial Statement Manipulation

There are many strategies a company may attempt to mask its financial condition or performance with the financial statements. One common method is called the “flow-in” tax provision. This is when a company issues a cash gift to itself, which is recorded as a tax payment on the company books. The company uses the money from the “flow-in” tax payment to meet its short-term requirements and then uses the cash from the remaining assets to meet its long-term obligations.

Another method is called the “flow-out” tax provision. This is when a company issues a cash payment to an entity that is not recorded on the company’s books. The entity then uses the cash to meet its short-term requirements and then uses the cash to settle its long-term obligations. When a company’s financial statements are “flowed out,” the company is reducing its reported cash as a means of masking its financial performance.

 

What causes financial statement manipulation?

The reasons for and causes of financial statement manipulation are numerous and complex. However, there are several common themes that are worth considering: - Lack of transparency and access to information - Lack of internal controls - Lack of fiduciary duty - Lack of required financial reporting - Lack of monitoring and review - Lack of a plan for financial statement integrity - Lack of proper accounting - Lack of adequate controls - Lack of transparency and access to information Some of the biggest causes of financial statement manipulation are a company’s inability to provide basic information to shareholders or the financial statements themselves.

If a company has no way to provide shareholders with a detailed financial statement or to view key financial ratios, they cannot be sure whether they are posting healthy or profitable results.

- Lack of internal controls Internal controls refer to processes that a company uses to prevent fraud and misappropriation of assets. Companies with effective internal controls are unlikely to engage in financial statement manipulations.

- Lack of fiduciary duty A fiduciary duty is a legal duty owed by a party to another to act in the best interest of that party’s shareholders. A company’s fiduciary duty is one of the most important factors in determining whether it is subject to financial statement manipulation.

- Lack of required financial reporting A company’s financial statements must be reviewed and approved by an accountant or financial advisor. If the accountant or financial advisor is unfamiliar with a company’s financial reporting methods or unable to provide appropriate oversight, the financial statements may be altered to reflect a less-than-optimal financial condition or performance.

- Lack of monitoring and review A company’s financial statements are the result of a process. While the process itself is important, a company’s ability to monitor and review the process to ensure that it is operating within parameters set by financial accounting rules is a significant sign of financial statement manipulation.

- Lack of a plan for financial statement integrity Just because a person or people break the rules once in a while does not mean that they are qualified to make financial decisions for a company. In fact, financial statement tampering and fraud are associated with people with no experience in financial investment or accounting.

A person who mounts a fraudulent claim or intentionally invents financial figures is called an “accountant’s thief.” A company’s lack of a plan for financial statement integrity is a strong indication that the company is at risk of financial statement manipulation. A well-drafted financial statement can provide a valuable view into the financial health of a business. If the financial statements are inaccurate, the company may owe taxes that it is unable to pay.

Date
2022-05-09