“Looking Behind

The Numbers”
Objectives:
• Discuss financial statements
– Why they matter
• Analyze financial statements 
and ratios to uncover stories
– Theft of assets
– Fake profits
– Hidden losses
• Apply training to strengthen 
reading and analysis of  Guide
companies’ finances
– Simplify the complex 
“Spotting irregularities in
financial and nonfinancial
disclosures made in
regulatory filings is a must
for investigative business
reporting. That often
means reading the fine
print and doggedly
attempting to understand
the financial information
and technical language.”
Olympus, AIG, Fortis Healthcare...
Olympus ─“One of the biggest and longest‐
running loss‐hiding arrangements in
Japanese corporate history“
Wall Street Journal

AIG ”suddenly collapsed in September 2008 under

the weight of bad bets it made insuring mortgage‐
backed securities. … [Federal] rescue packages
brought the total to $182 billion, making it the
biggest federal bailout in United States history.”
New York Times

“The Economic Times of India questioned

whether Fortis Healthcare India was paying a
premium of as much as 20 percent to buy a
family owned healthcare business.” Guide
 Many Stories To Uncover ─ Why?
Pressure  “Intentional,
Management increasingly driven to generate  deliberate,
profits in tough economic times misstatement or
omission of material
Unethical business practices  facts, or accounting
data which is
• One‐in‐five surveyed saw financial 
misleading and, when
“manipulation” in their companies
considered with all the
• 57% believe bribery and corruption are  information made
widespread in their countries available, would cause
the reader to change or
Compliance works, but not well enough alter his or her
judgment or decision.”
Ernst & Young, 2013 fraud survey
Association of Certified Fraud 
Examiners
Cooking The Books
“An alarming number
appear to be comfortable
with or aware of unethical
conduct. This includes
recording revenues early;
under‐reporting costs or
encouraging customers to buy
unnecessary stock. This is
coupled with the perception
that bribery and corruption
remain widespread in several
markets.”
David L. Stulb
Ernst and Young
Hiding Losses, Inflating Profits
Company Accounting Frauds Losses

Satyam  Manipulated accounts to disguise losses  $1.8 billion 

Parmalat Falsified accounting documents to hide:  non‐ Bankruptcy in 2003

existent cash in bank; fake transactions; debts; use 
of derivatives  $20 billion
• Hid huge debts off the balance sheet through  $74 billion
Enron complex structures
• Inflated revenue and profits Bankruptcy
Scandal wiped out 75% 
Olympus Accounting disguised investment losses stock value ($6 billion)

Perwaja Joint venture between government‐owned and  Malaysian Ringgit10 

Steel  private steel company used accounting frauds to  billion ($3 billion)
(Malaysia) hide theft of assets, other crimes
Dissect Financial Statements
• Statement of Financial Position (“balance  “They show where a
sheet”) company’s money
– Financial health  came from, where it
– “Snapshot"  went, and where it
is now.“ SEC
• Statement of Comprehensive Income 
(“profits and loss” or “P&L”)
Maintain a healthy
– Performance
skepticism toward
• Statement of Cash Flows all financial reports
– Changes in financial position
• Notes “Details create the
– Most interesting information to uncover  big picture.“
fraud
– What’s hidden? Why?  
Balance Sheet
Snapshot of a
company at
close of
reporting
period:

• Assets

• Liabilities

• Shareholders’
equity
Example

Source:  Accounting Coach
 Assets (Left Side)
Assets help
• Current:  turn to cash or to be depleted within 
companies:
one year of balance sheet date (e.g., inventory) • weather
• Noncurrent:  not likely to convert to cash within  emergencies
one year (may take longer than one year to sell) • borrow at
• Investments:  stocks, bonds, and life insurance  lowest rates
policies company owns for top executives   • promote long‐
• Property, Plant, and Equipment (“fixed”)   term thinking and
growth
• Intangible: copyrights, patents, goodwill, trade  • earn high stock
names, trademarks prices
• Other Assets:  bond issue costs amortized to 
expense over bonds’ life; property readied for 
sale Company’s assets
have to “balance”
• Vary greatly year to year
Apple: Assets
 Liabilities (Right Side)
• Liabilities:  company’s obligations during  business  Helps audience
operations (listed by due dates) to quickly detect
• Current liabilities:  expect to pay off within the  the financial
year strength and
capabilities of the
• Wages business
• Accounts 
• Taxes  Rising liabilities
• Long‐term liabilities: obligations due more than  may signal
one year away problems

• Long‐term bonds/debt (principal and interest) Value may be

• Leases  reduced
• Pensions, other retirement benefits 
• Product warranties
Apple: Liabilities
 Shareholder Equity Helps audience
to quickly
“Net Worth” detect the
financial
= Assets – Liabilities strength and
Or capabilities of
the business
= Capital + Retained Earnings –
Treasury Shares Typical changes
in equity result
• Share capital:  portion of company held as  from company
stock profits or losses,
• Retained earnings:  profits dividends, or
• Treasury shares:  shares the company sells  stock issuances
and then repurchases
Apple: Shareholder Equity
Income Statement
• Sales (Minus) Cost of Goods = • Amount of revenue
a company earned
Gross Profit over a specific
• (Minus) Expenses = Net  time period
Operating Income (usually one year)

• (Minus) Other Income and  • Costs and expenses

Expenses associated with
earning that
• (Minus) Extraordinary Items revenue
• (Minus) Income Taxes =
• “Bottom line”
• Net Income (Profits) reveals company’s
• Retained Earnings (if any) net earnings or
losses
Apple Income Statement
 Cash Flow: Key Terms
Cash generated and used during the  To survive and succeed,
interval specified: every business depends
• Operations:  day‐to‐day business  on its ability to create or
operations otherwise attain cash.
• Investing :  asset investments and 
proceeds from the sale of other  Strong cash flow allows
businesses, equipment, or other  a company to increase
long‐term assets dividends, develop new
products, enter
• Financing:  cash paid or received  new markets, pay off
from issuing and borrowing of funds  liabilities, buy back
(includes dividends paid) shares, and become an
• Net Increase or Decrease in Cash acquisition target.
Cash Flow Statement
How much money
did the company
generate?

Where is the cash

coming from?

Can the company

pay its bills?

Does it have
money to expand?
Apple Cash Flow
Financial Ratios Analysis
• A comparison is more useful than “absolute numbers”
• Analysis of financial ratios involves two types of 
comparisons:
– Present ratio with the past ratios & expected future ratios
– Ratios of one firm with those of similar firms or with industry 
averages at same point of time
• Essential to consider nature of business   
Classification of Financial Ratios

• Liquidity ratios

• Leverage / Solvency ratios

• Turnover / Activity ratios

• Profitability ratios

• Valuation ratios
Liquidity Ratio Example

CURRENT RATIO (CR):

• Measure of company’s ability to meet short term requirements

• Indicates whether current liabilities are adequately covered by 
current assets

• Measures safety margin available for short term creditors

• CR = Current assets/Current liabilities

• If Net Working Capital is to be positive, CR >1
Leverage Ratio Example

DEBT TO EQUITY RATIO (DER):
• Measures relative proportion of debt & equity in financing assets 
• Company can have good current ratio and liquidity position, 
however liquidity may have come from long term borrowed 
funds, the repayment of which along with interest will put 
liquidity under pressure 
• DER = Long term debt / Share holders funds
• Creditors would like this to be low;  Lower ratio implies larger 
credit cushion (margin of protection to creditors)
Turnover Ratio Example
INVENTORY TURNOVER RATIO:

• Measures Number of times inventory turned over in a year
• Times Inventory turned over =  Net sales  divided by Average Inventory
• A ratio of 6 times  indicates inventory turned over six times in a year
OR 
Ratio of 60 days indicates enough inventory to support sales for 60 days 
held by company
• Excessive inventories unproductive; represent investment with zero rate 
of return
• Conversely less inventory results in loss of customers
Profitability Ratio Example

• Profitability ratios indicate

• Company's profitability in relation to other companies

• Internal comparison with last year’s profits

• Managements effectiveness as shown by returns 
generated on sales and investments
NET PROFIT RATIO :
• Net profit margin ratio (NPMR) = Net Income divided by Revenues
Example of Valuation Ratio

DIVIDEND PAYOUT RATIO :

• Shows amount of dividend paid out of earnings

• An indication of amount of profits put back into company

• Important ratio to assess long term prospects of company

• Dividend Payout Ratio = Dividend / Net Income
Financial Statements ─ Notes
• Enhance understanding of financial 
statements 
What accounting
• Contain accounting policies, key  methods were
assumptions and judgments made in  used for
preparing the financial statements recording and
• Explain items in greater detail (for example,   reporting
pension accounting assumptions) transactions?
• Provide detail on any uncertainties
Assets
• Required by national or  listing  overvalued?
requirements
• Some companies voluntarily provide  Liabilities
additional information undervalued?
 Earnings Manipulation
• Recording revenue too soon
• Booking bogus revenue
• Boosting income using one‐
time or unsustainable 
activities
• Shifting current expenses to 
a later period
• Employing other techniques 
to hide expenses or losses
• Shifting current income to a 
later period "I give you the seven‐billion‐dollar 
pup, then you give me back the 
• Shifting future expenses to 
an earlier period  seven‐billion‐dollar pup, and 
SOURCE: Schilit/Perler, Financial Shenanigans
we’ve each made seven billion 
dollars.”
 AC/Controls Audit Risk Compliance Disclosure

External Audit vs. Internal Audit

External audit means business  Internal audit means an 
activities involving independent  independent, objective 
audit of accounting records and  assurance and consulting activity 
financial (accounting) reporting  designed to add value and 
of companies and individual  improve an organization’s 
entrepreneurs operations. It helps an 
organization accomplish its 
“The most common auditor failings objectives by bringing a 
were lack of competence and systematic, disciplined approach 
diligence, lack of professional to evaluate and improve the 
skepticism, and failure to assess and
effectiveness of risk 
respond to fraud risks,” according to
a 2013 study. management, control, and 
governance processes 
Reuters May 9, 2013 

30
Unqualified vs. Qualified Opinion
Auditor’s report helps attract investors, obtain 
loans, and improve public appearance
Unqualified/”clean” opinion Auditors may fail to:
Financial statements give a “true and fair” view,  • gather sufficient
comply with:  evidence to verify
• Accounting principles management’s
information
• Relevant statutory requirements, regulations
• exercise
• Disclosure obligations of all material matters professional care
– Changes in accounting principles, methods  • be sufficiently
Qualified ─ not good skeptical
Information incomplete and/or the company has  • express the
not prepared statements according to sound  appropriate opinion
accounting principles 
 Red Flags
Topics Questions
Changes Size? Reasons?  
Make sense in light of economy?  

Accounting New accountants, auditors?
Methods changed in valuing assets, liabilities
Risks Properly assessed and prepared for?

Footnotes Insights into relationships with clients, suppliers?

Debt Increase?  By how much?
Company’s revenues adequate to repay loans?
Lawsuits From investors, vendors, competitors, government?
Why? 
Management  Unaudited information – shed light on soundness of business 
Discussion and Analysis model and management’s style?
Growth outlook realistic?
Case - Enron
Questions
Action Ideas
• I plan to apply the following ideas, skills, and 
procedures:
• Obstacles that may prevent me from 
implementing improvements in my reporting 
and analysis are:
• Opportunities to acquire skills and resources 
include:
THANK YOU