Analysis of financial statements is an essential preliminary step in any audit, i.e. statutory, internal or forensic. Ratio analysis is a proven mathematical and scientific method to understand the root cause and critical risk factors. Further, trends and patterns are among the key signals used by professionals in understanding any anomalies / suspects of irregularities.
More particularly for Forensic Accounting and Investigations angle, trends can be of two types:
- Actual trends and patterns (symmetry / peculiar pattern observed across a time frame)
- Scattered one-off events / transactions correlated with timelines
In order to review and understand type one of the above-mentioned types, ratio analysis is an effective method. As understood, routine Activity, Profitability, Solvency and Investment ratios are traditional ways of going about things. Further, correlation analysis, Beneish M-Score, Altman Z-score, etc., are advances ratio analysis ways, where multiple ratios are correlated to give a broad understanding of various factors.
However, it is essential to understand how even a “one-off” event / transaction is also a type of “trend / pattern”. Further, these one-off events could be qualitative and quantitative and would eventually tip-off on the psychology, behaviour and governance of the management and executives. For example, the resignation of KMPs / Independent Directors, declaring a dividend, paying performance-linked incentives, significant change in shareholding, sale of assets, write-off / write-back effect, etc. – when such one-off events / transactions are looked at from the perspective of motive / intent and correlated, it might as well be understood that such one-off events and transactions were possibly detrimental to the interest of the organisation.