How to Prevent Creative Accounting

Creative accounting is a term used by companies to hide the practice of altering their financial statements. In most cases, this is done to reflect higher earnings or to avoid reporting a loss. Creative accounting is especially common in companies that need to show a good balance sheet in order to attract or keep clients, such as in the case of a company that is going up for sale or one that depends on investors. Avoid unscrupulous practices by reading on to learn how to prevent creative accounting.

Difficulty: Moderate

Instructions

1. Focus on cash flow rather than income numbers. If you pay close attention to the cash flow, you’ll notice that it becomes hardly impossible to hide numbers there. The two most common ways to alter financial statements is to either create fictitious revenue or to shift revenue or expenses to a different period than the one where they actually happened. By looking to cash flow and check statements, you can easily verify dates and compare numbers.

2. Put more than one person in charge of the accounting. Rather than having a single person or even a couple working in a shared office, have a step system, in which financial statements are reviewed and processed by a series of different people in separate areas of the company. This will make it harder for somebody to change numbers without being caught later on in the process.

3. Don’t let investors and partners mix company business with personal investments. It’s easy to hype sales or revenues if a partner is investing his own money to buy shares or fund purchases that ultimately benefit the company. This is especially important if all the sales happened within a short period of time, before the company went up for sale or changed from private to publicly listed.

4. Have an independent auditor go over the statements after they have been tallied up by employees. Bringing an outsider into the mix is an almost fool-proof way of stopping creative accounting, as people inside the company would usually not risk being found out.

Tips & Warnings

• When checking for signs of creative accounting, pay attention to statements from prior months or years. A company that reported large losses and suddenly changed to big profits may be playing with numbers in order to better their image.