{"id":991,"date":"2007-09-18T11:20:06","date_gmt":"2007-09-18T16:20:06","guid":{"rendered":"http:\/\/www.sequence-inc.com\/fraudfiles\/2007\/09\/18\/finding-fraud-by-looking-at-ratios\/"},"modified":"2007-09-18T11:20:49","modified_gmt":"2007-09-18T16:20:49","slug":"finding-fraud-by-looking-at-ratios","status":"publish","type":"post","link":"https:\/\/www.sequenceinc.com\/fraudfiles\/finding-fraud-by-looking-at-ratios\/","title":{"rendered":"Finding fraud by looking at ratios"},"content":{"rendered":"

While doing some research, I came across an old article written by Joe Wells on analyzing ratios to find fraud. The article Irrational Ratios<\/a> was published in the Journal of Accountancy, and used the ZZZZ Best case to illustrate the point.<\/p>\n

I’m a believer that today’s really good fraudsters manipulate the financial statements so that the ratios are in line with expectations. Executives who are committing fraud know what the financial statements should<\/strong> look like. So we can’t always assume that normal-looking financial statements are free from fraud.<\/p>\n

Yet sometimes there’s too much to keep track of, and flaws in the financial statements are revealed with ratio analysis. The longer a fraud goes on, the greater the likelihood that a clue may turn up.<\/p>\n

Wells uses this illustration to show where ZZZZ Best’s numbers went wrong. A simple comparison of ratios between years reveals something is going on. (Yoo hoo! Auditors????)<\/p>\n

 <\/p>\n

<\/p>\n\n\n\n
Exhibit 1: Selected Ratios From ZZZZ Best<\/strong><\/font><\/td>\n<\/tr>\n
\n

 <\/p>\n

<\/p>\n\n\n\n\n\n\n\n\n\n\n\n\n
 <\/td>\n1985 <\/strong><\/font><\/td>\n1986<\/strong><\/font><\/td>\n<\/tr>\n
Current ratio of assets to liabilities<\/font><\/td>\n36.552<\/font><\/td>\n.0977<\/font><\/td>\n<\/tr>\n
Working capital: Total assets <\/font><\/td>\n0.5851<\/font><\/td>\n(0.0080)<\/font><\/td>\n<\/tr>\n
Collection ratio <\/font><\/td>\nN\/A<\/font><\/td>\n26.131<\/font><\/td>\n<\/tr>\n
Asset turnover <\/font><\/td>\n.144<\/font><\/td>\n1.041<\/font><\/td>\n<\/tr>\n
Debt to equity ratio <\/font><\/td>\n.017<\/font><\/td>\n1.486<\/font><\/td>\n<\/tr>\n
Receivables turnover<\/font><\/td>\nN\/A<\/font><\/td>\n6.984<\/font><\/td>\n<\/tr>\n
Times interest earned<\/font><\/td>\nN\/A<\/font><\/td>\n43.136<\/font><\/td>\n<\/tr>\n
Cost of sales: Sales <\/font><\/td>\n.465<\/font><\/td>\n.423<\/font><\/td>\n<\/tr>\n
Gross margin percentage<\/font><\/td>\n53.51%<\/font><\/td>\n57.68%<\/font><\/td>\n<\/tr>\n
Return on equity <\/font><\/td>\n183.75%<\/font><\/td>\n46.58%<\/font><\/td>\n<\/tr>\n<\/table>\n

<\/center><\/td>\n<\/tr>\n<\/table>\n

<\/center>Wells notes:<\/p>\n

These numbers make no sense at all\u2014they are all over the place. Particularly revealing are the current ratio and the debt to equity and return on equity ratios. The current ratio shows a company with no cash in 1986 despite record \u201crevenues.\u201d The 1986 debt to equity ratio is up 8600% from the prior year; return on equity has dropped by more than 75%. These are not indicators of a legitimate business.<\/p><\/blockquote>\n

Other clues to the fraud at ZZZZ Best:<\/p>\n