Financial statement fraud: 3 red flags to watch out for

Accountants have a duty to report financial information accurately and honestly. However, some may intentionally manipulate the numbers. They may inflate revenue or hide expenses to make the company look more profitable. They may also do this for personal gain, such as securing bonuses tied to financial performance.

Regardless of the reason, manipulating financial statements is against the law, and it can badly hurt your business. You can lose investor trust, face hefty legal penalties or even risk bankruptcy. Spotting the warning signs early is key to keeping your business safe and honest.

Sudden or significant changes in revenue

Look out for sharp increases in revenue that don’t match cash flow growth. Suspicious changes can include:

• Unusual jumps in sales, especially near the end of reporting periods
• When the revenue grows much faster than the industry average or doesn’t fit current economic conditions
• Frequent sales to a small group of customers or big deals with related parties

These patterns might mean the company is recording fake sales or counting money too early.

Inconsistencies between financial reports and other business documents

Differences between financial reports and other business documents can reveal fraud. To spot potential issues:

• Compare sales figures in financial statements with actual sales records
• Match inventory amounts in financial reports to inventory logs
• Find expenses in operational documents missing from financial statements
• Check customer numbers and order amounts across sales reports and financial statements

Big gaps in sales figures may show inflated revenue. Mismatched or missing information might also point to hidden or made-up numbers.

Abrupt changes in key financial metrics

Sudden changes in financial ratios can reveal manipulation when there is no clear business reason for the shift. Keep an eye on:

• Any jumps in the debt-to-equity ratio, which could mean hidden liabilities or inflated assets.
• Sharp increases in profit margins, which might show inflated revenue or underreported expenses.
• Significant changes in days sales outstanding (DSO), which can point to fake sales or altered payment terms to boost performance.

Make sure to document all suspicious findings and any unexplained discrepancies. An attorney can help you investigate suspected fraud and consider your legal options.

Early intervention is key

If you notice any of these red flags, don’t hesitate to consult a legal professional.