Question

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The Statement of Cash Flows contains information on how much cash a company has generated and used during a given period. It contains 3 sections: cash from operations, cash from investing and cash from financing.

Financial statement fraud can surface in many different forms, although once deceptive accounting practices are initiated, various systems of manipulation will be utilized to maintain the appearance of sustainability. Common approaches to artificially improving the appearance of the financials include: overstating revenues by recording future expected sales, understating expenses through such means as capitalizing operating expenses, inflating assets' net worth by knowingly failing to apply an appropriate depreciation schedule, hiding obligations off of the company's balance sheet and incorrect disclosure of related-party transactions and structured finance deals.

Statement of cash flow could be used to spot red flags, it can be extremely challenging as firms that are engaged in fraudulent activities will attempt to portray the image of financial stability and normal business operations. Vertical and horizontal financial statement analysis introduces a straightforward approach to fraud detection. Vertical analysis involves taking every item in the income statement as a percentage of revenue and comparing the year-over-year trends that could be a potential flag cause of concern.
Also, statement of cash flow would provide with comparative ratio analysis, also allows analysts and auditors to spot discrepancies within the firm's financial statements. By analyzing ratios, information regarding day's sales in receivables, leverage multiples and other vital metrics can be determined and analyzed for inconsistencies.

Answer 1

Financial frauds are considered to be very difficult to be caught since they are mainly performed by top executives who can easily overlook internal controls. In such case we require careful analysis of various aspects. Analytical procedures can help a lot in such cases. Analytical procedures are none other than analyzing ratios on the basis of past ratios and try to forecast for the current as well as future considering there is nothing material change.

We can perform vetical analysis which will help us finding any inconsistency between two same item over the year which can be further corroborated by the statement of Cash flow. Further we can also use days sales in receivable as well as inventory turnover and various other ratios. Also operating leverage and financial leverage will help us in finding is there any material change in operating or financial expense as a whole.

So all these financial ratios and analysis and analytical procedure can be used to uncover financial statement frauds to find any inconsistency in various items.