How far would you go to save your business? If you’ve spent any time thinking about this question, you’ve likely formulated an answer along the lines of “I’d go as far up to the line as possible, but I wouldn’t cross it.” Crossing the proverbial line means doing something you know is dishonest, unethical or even illegal. Yet if you ask many business owners who have been convicted of accounting-related fraud how they answered this question before getting into trouble, they claim their answer would have been no different. Many still don’t understand how they went from law-abiding citizen to convicted criminal. While each case is different, they do share something in common: that first step.
Operating Under Pressure
At some point during its lifecycle, it’s likely your business will face a finance-related crisis that it may not be equipped to survive. These situations usually involve being approved for a line of credit, a bank loan, investment from venture capitalists or winning a cash-rich contract from a new client. Your business may be starved for cash, your personal finances may be pushed to the limit and you absolutely need to close the deal to survive.
Securing one of these prizes usually requires an evaluation of your company’s finances, and there are specific criteria related to cash flow, profitability, leverage and revenue growth that you must meet to be approved. What if you’re close but not quite there? How will you handle this situation? This is where some entrepreneurs get into trouble. Many have good intentions; they don’t want to fire their employees, lose their homes, have their families suffer or have and their employees’ families suffer.
It’s at this point where some decide it’s in everyone’s best interests to “fudge the numbers” a little for the month or the quarter, secure the financing or the new client at stake, perform well and no one is hurt. It’s a victimless crime where everyone wins.
Common Ways to Cook the Books
When business owners choose to fudge the numbers, it usually involves the income statement. Some common tactics include:
Boosting revenues by recording them prematurely. Under the revenue recognition principle, revenues should be recorded when they are earned. A company in the service sector might violate this principle by offering a multi-year contract to a customer at a deep discount and deciding to report the entire contract value as revenue during the current period.
Boosting revenues through fake sales. For companies that sell goods, it isn’t that difficult to fake additional sales. Many will ask a friendly customer to place an order that's shipped on the last day of the month. Since a sale has been made and shipped, this can be recorded as revenue for the month. The customer, however, has no intention of keeping the items. As soon as they arrive they’ll return them. After the returns are processed the sale will be reversed, but this won’t happen until after the company has closed its books for the month and allowed them to make their numbers.
Boosting profits by shifting expenses into the future. There are many ways to make expenses appear less than they are. One simple way is to misclassify an asset for purposes of depreciation. If a $500,000 asset has a useful lifespan of 10 years, then under straight-line depreciation this would mean a $50,000 depreciation expense would be recorded each year. Falsely assuming a 50-year useful life would drop that expense to $10,000, boosting profits.
You Will Get Caught
Sadly, the end result of accounting fraud is that usually everyone loses. The undeniable reality is that accounting fraud will be discovered. The longer it goes undetected, the greater the damage and the graver the consequences. According to the FBI Financial Crimes Report to the Public, investigations and prosecutions of corporate fraud by the FBI, Department of Justice and Securities and Exchange Commission are up significantly over the past five years. The FBI may not have a surveillance team following a small-business owner for recording uncertain revenues, but it does mean that banks, investment funds and corporations are very aware of the problem and are instituting policies to protect themselves. They don’t want to risk associating themselves with anything inappropriate and are therefore conducting very thorough due diligence before agreeing to anything. Should your misdeeds be discovered, the best outcome would be the client or financier walks away; the worst could be criminal prosecution.
It takes a lifetime to build a reputation but only a few clicks in Excel to destroy it permanently. It isn’t worth the risk. When you are faced with the defining moment, do what’s right. You’ll be able to sleep better at night.
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