Like people, companies like to put their best foot forward—even if that means playing fast and loose with the truth on occasion. The right financial profile can help you secure funding, cement partnerships, and attract investors. As a result, the temptation to, ah, “massage the truth” is ever-present. That’s why cooking the books—a slang term for intentionally misrepresenting your company’s financial results to make them seem healthier than they actually are—is both alarmingly common and absolutely laden with the potential for financial and reputational ruin.
Fortunately, identifying and understanding the most common ways companies choose to cook their books, along with an investment in the right technology and practices, can help you avoid running afoul of the law or damaging your company’s standing, success, or survival.
The Dangers of Cooking the Books
When companies make the choice to lie about their financial statements in order to increase reported earnings while decreasing reported expenses (and thereby improving their bottom line), that’s cooking the books.
While it might seem like a quick and easy shortcut, the truth is this kind of “creative accounting” exposes a company to devastatingly high levels of risk. Consider these dangers:
- Corporate fraud is a crime. Both the parent company and the person(s) directly responsible for altering the financial records will likely suffer substantial penalties if caught, including fines, prison time, and even the shuttering of the company itself.
- Corporate misdeeds can sour public perception and professional reputation permanently. Even if a company manages to ride out the legal ramifications of their scam, they may find themselves unable to attract or secure investors, employees, suppliers or customers. Add in the risk of tumbling stock prices, and the company may not be around long enough to apologise, let alone recover.
“The dangers of cooking the books are hardly news to anyone who’s heard the sordid tales of companies like Enron, Adelphia Communications, and Worldcom—fallen titans whose corporate misdeeds devastated lives, sent executives to prison, created widespread financial ruin for investors, and caused the companies themselves to implode.”
Common Ways Companies Cook the Books
The dangers of cooking the books are hardly news to anyone who’s heard the sordid tales of companies like Enron, Adelphia Communications, and Worldcom—fallen titans whose corporate misdeeds devastated lives, sent executives to prison, created widespread financial ruin for investors, and caused the companies themselves to implode. Worldcom in particular set records as one of the very largest bankruptcies in United States history.
In the United States, legislation like the 2002 Sarbanes-Oxley Act (SOX) was directly inspired by the need for reform in the wake of Enron and other scams. Designed to shield investors from accounting fraud, SOX instituted several important protections, including:
- Stricter corporate governance regulations, including the creation of the Public Company Accounting Oversight Board (PCAOB) to actively monitor corporate accounting practices.
- Eliminating fraud-friendly loopholes in common accounting practices.
- Strengthening requirements for both financial disclosures and corporate accountability, including increased accountability for executives, auditors, and accountants.
- Tightening transparency requirements for corporate financial reporting.
- Stronger protections for whistle-blowers.
- Increased compliance monitoring.
- Larger financial and legal penalties for malfeasance perpetrated by corporations and their executives.
Yet despite reform legislation like SOX, companies continue to search for, and indulge in, financial sleight of hand in search of maximum gain for minimal effort. Some of the ways companies continue to perpetrate this kind of fraud include:
When a customer buys goods or services on credit, they can be recorded as sales even if the customer’s credit terms allow them to delay payment for 90 days, six months, etc. Companies offering their own financing programs to customers can extend credit terms, too. The result? “Sales” that hit the balance sheet as (false) net income, while the buyer’s funds are still safely nestled in their bank accounts.
Playing Fast and Loose with Expenses
Companies can manipulate their expenses in a few different ways to pump up their financial statements.
- Delayed Expenses, which aren’t recorded as costs when they’re actually incurred. Telefonaktiebolaget LM Ericsson, the Swedish electronics firm, was caught delaying expenses—to the tune of nearly a billion dollars—in 2018.
- Accelerated Pre-Merger Expenses involves a company about to be acquired in a merger paying, or even prepaying, all the expenses it possibly can before the merger occurs. When the merger is finalized, these expenses will be on the books for the period before the merger—and earnings per share for the stock of the newly created company will seem much healthier.
- Non-Recurring Expenses are single, one-time charges connected to unusual events, intended to provide a company’s investors with greater insight into operations. Some companies may skirt the line of propriety and legality by making these “extraordinary” expenses a standard part of their yearly budget, then claim they overdid it and return part or all of the charges to income once at their convenience.
- “Other” Expenses and Income is a broad, bland, and infinitely exploitable category where companies can conceal expenses by offsetting them against income from (for example) the sale of equipment.
While employees may enjoy having a benefit plan to build a retirement nest egg, companies can also manipulate pension plans to boost earnings by lowering the plan’s reported expenses. The scheme here is to report the investment gains generated by the plan’s assets as revenue.
Keeping Your Books Compliant, Not Cooked
Keeping corporate fraud and other creative accounting problems at bay can be challenging, especially if your current business processes are too opaque and labour-intensive for you to spot the warning signs.
Choosing to invest in a comprehensive procurement solution like PurchaseControl can help. Connecting procurement to accounting and centralising the capture, organisation, and analysis of all financial data makes it a lot easier to spot potential problems before they become catastrophes.
Using process automation and levelled access to data, you can create a closed datasphere where all purchases are routed through the system, all payments and expenses are recorded, tracked, and available to review from dashboards on demand, along with advanced financial reporting and analysis.
Audit trails are automatic, and built-in compliance measures like automatic three-way matching, levelled account access to critical accounting information, and advanced process management for approval workflows ensure that your financial records are complete and compliant.
A Recipe for Financial Compliance
Accurate and complete financial records aren’t just good business—they’re essential to your company’s ongoing health, reputation, profitability, and competitive performance. You can make sure your financial records are audit-ready by establishing rigorous review practices, monitoring your accounts regularly, and making automation and artificial intelligence part of your accounting software environment. With a little preparation, the right tech, and a commitment to integrity and honesty, you’ll be able to rest easy knowing your company’s books are anything but cooked.
Ensure Your Financial Records are Complete, Accurate, and Compliant with PuchaseControl.Find Out How