The controller of a manufacturing plant noticed that his financial statements showed the company was doing well and making money, but his bank statement said they were broke. The controller asked me: “How can we have this paradox? If our company has strong sales, and collections are not an issue, why don’t we have any cash?” Based on my experience as a forensic accountant and former controller, I knew there was no simple answer to his question.
On the surface, one might immediately assume that someone within the company was stealing cash, but before accusing someone of stealing, a financial investigation needed to be conducted. In the above situation, my investigation revealed three main issues:
Issue #1: The processes for recording the material used by manufacturing were based on estimated consumption rates and never compared to actual consumption rates. Therefore, the company did not know the true material cost to build its products, resulting in its gross margins being inflated.
Issue #2: A lack of communication between operations, sales and accounting meant that no one in sales knew that the inventory prices provided by the company’s system to estimate new product costs were incorrect because the inventory had already been used. Thus the system provided inaccurate information, and the company had to purchase more materials at higher current market prices.
Issue #3: The company’s policy was to give quantity discounts, but they did not consider the effects of the discounts combined with the inventory pricing issues when setting the selling price. Thus larger orders were being sold a price that did not generate enough profit to cover overhead.
It does not take long for these types of issues to start affecting the health of a company and, based on the speed of financial reporting, by the time it is discovered, the company may be in serious financial trouble. Often, companies are unsure of where to turn when this happens.
What is a Forensic Accountant?
A forensic accountant is someone who has typically been classically trained as an accountant but has focused their career on developing a mindset to find out why and how problems have arisen. This dedication and experience are paramount. In addition, most forensic accountants have attained either the Certified Fraud Examiner (CFE) or Certified Financial Forensic (CFF) certification. This shows not only their dedication to their craft but also that they have additional experience and training in investigating problems.
Although forensic accountants are often associated with issues related to financial fraud, in reality, the same investigative skills can be used to solve other problems. Forensic accountants go beyond just looking at financial data; they look at areas of operations and interview personnel to find the underlying issues to the problem at hand.
How can a forensic accountant help my business?
- Forensic accountants are good at digging in deep and finding the root causes related to operational or financial problems.
- If a project or product is not making the profit margins you originally expected, a forensic accountant can help find the cost associated with the project or product and assist you in determining which course of action to take to correct the issues.
- If you think your business is spending too much money in a particular area, a forensic accountant can investigate and assist in determining if the expenses are appropriate.
- If operations are not going as smoothly as expected, a forensic accountant can use his or her skills to interview people, examine documents and get to the root causes of the issues.
To bring this to life, let’s go back to our manufacturing plant. This investigation included:
- Interviewing operations personnel to find out if there were inventory shortages, how much material was scraped during the manufacturing process and how they reported the material used on each project.
- Interviewing the accounting personnel to find out how operations reported material usage.
- Interviewing the sales personnel to gain an understanding of how they priced items.
- Analyzing the accounting data to see if it flowed in the same manner as was outlined in the interviews.
- Looking for anomalies in the accounting data that indicate additional issues that need further investigation. The analysis often gets very granular as problems are often hidden from a standard accounting analysis.
- Evaluating other possible reasons for the problems and testing the likelihood of these being the source of the issues.
The result? After conducting all the interviews and following how documents and information flowed, we uncovered that design modifications had been made along the way to compensate for temporary shortages. Because the issue was identified, we were able to remedy it by reducing the number of different design variations by 25%. This allowed for the cost to come down and set-up times to shorten, reducing overall labor spent making the products. Consequently, the company’s profitability improved dramatically.
The bottom line
Forensic Accountants track problems to their source and provide companies with critical information as to what happened, why and how to fix it. It does not matter if the problem involves a potential fraud or trying to figure out why you’re not making more money. The next time you hit a wall and need help with a problem, consider hiring an experienced forensic accountant.
Rusty Lane, CFE, CGMA, CPA, is a Director in Moore Colson’s Consulting Practice. He works in the Special Services Group helping clients with unique accounting issues including forensic or litigation assistance.