Forensic Analysis of Financial Statements - Can I do?

Forensic Analysis - Financial Soldier Series Part-1 

FINANCIAL ANALYSIS BASICS

Preamble

There is a lot of buzz about one most heard world 'Financial Analysis' or 'Forensic Analysis of financial statement' among students and newcomer professionals. Forensic is a new buzz word which gained lots of attention of everyone in last 7-8 years.

Burning Questions

A various question comes to one's mind what is financial analysis? How to do the financial analysis? How to interpret financial statement? How to find fraud in the financial statement? How to identify financial misstatement? Etc. Full stop because the list is pretty long.

Well, I will try my best to answer all these burning and mind eating questions which come to your mind. Trust me Forensic Analysis of financial statement is not a big deal but you need to change only your approach. (Will discuss in detail in coming articles).

Why I titled this series as 'Financial Soldier'?

Our journey will start from Basic to Intermediate (not advance because it needs experience which you will gain on your own) i.e. From Financial Analysis to Forensic Analysis. If you are good at financial analysis then half job is done, forensic analysis is not a big deal rather I will say enhanced version. The way, our army protect us, the same way, forensic investigator protects the interest of various stakeholders and uncover or prevent frauds that's why I call it as the financial soldier whose mission or object is always to find a fraud and save stakeholders.

Starting with the answer

Firstly bear in mind that there is no standard operating procedures or standard formula or defined parameters based on which financial analysis is done. Then you may ask what I am going to discuss with you all, the answer is 'the way of financial analysis'. Financial Analysis Outcome is the professional judgment or prudent derived based on experience and analytical skills.

Difference between Statutory Audit and Forensic Audit

Difference between Normal Audit and Forensic Audit is 'Audit with Closed Eyes and Audit with Open Eyes' (personal perception from Experience)

In last, let me clear one thing: 'I can show you Direction but you have to walk on path'.

So, about SCOPE that I will cover:

Part - 1 Financial Analysis:

1. What is financial analysis? Usefulness of financial analysis.
2. Understanding Business and Industry in which company operates: PESTLE Analysis, SWOT Analysis, and Porter's five forces model
3. Methods of financial analysis: Horizontal Analysis, Vertical Analysis, Ratio Analysis, Peer Comparison

Part - 2 Forensic Analysis

1. About Forensic and Financial Misstatement including facts and figures
2. Z score, M Score, O Score, Benford's law, Relative Size Factor (RSF) Test etc.
3. How financials are manipulated i.e. Methodologies followed?

Part - 3 Practical Case Studies

Note: Financial Analysis and Financial Statement Analysis often taken as Synonym to each other which is wrong. Financial Statement Analysis mainly deals with 'QUANTITATIVE ANALYSIS' i.e. Analysis of Balance Sheet, Profit-Loss Statement & Cash Flow Statement etc., and qualitative factors are not covered. While Financial Analysis covers the broader scope than financial statement Analysis and includes 'QUANTITATIVE AND QUALITATIVE FACTORS' into consideration, for e.g. Changes in Management, Regulatory Changes, Natural events like earthquake etc.

Let's Begin our journey, I hope it will enlighten your mind and knowledge. Starting with basics of financial analysis i.e. meaning and users of financial analysis. Here we go !!

Financial Analysis

Financial analysis (also referred to as financial statement analysis or accounting analysis or Analysis of finance) refers to an assessment of the viability, stability, and profitability of a business, sub-business or project. (Source: Wikipedia)

In layman language, to check the genuineness of business or to know true net-worth of the entity or say to know repayment capability of any person or entity. Financial Analysis deals for Present + Future.

Users of Financial Analysis:

Users of Financial Analysis not only include Shareholders and Lenders but includes all stakeholders like Supplier or Creditor, Customers, Government etc.

1. Existing or Prospective Investor

Based financial analysis one can estimate or predict probable growth of the business which is useful for taking the decision whether it is advisable or not to continue hold shares of the company for existing investors, and for Prospective Investor whether to invest fund or not at this moment.

2. Management

As per my understanding, Management is the biggest user of Financial Analysis. Based on Past and Present information, various crucial decisions are taken for future. Like, Long-term business plans of capacity expansion, Cost reduction decisions, whether to discontinue any product line & Segment or not etc.

3. Lenders

Lenders like banks and financial institutions are interested to understand credit profile of borrower i.e. know future prospectus and repayment capacity of the borrower.

4. Suppliers or Customers

• Suppliers are interested to know credit profile, operational efficiency, and payment ability.
• Customers are interested mainly in Operational efficiency and business continuity etc. This may happen when Customer has significant dependency on the entity for its operations.

5. Competitors     

It is very obvious that Competitors are interested to know business strategies, Cost structure, various product innovations, SWOT analysis etc. of rival and so, performance evaluation can be done in relation to rivals.

6. Specific Users

• Like Government may be interested in knowing financial profile changes for a particular period for a specific sector or Industry, so that information can be used to take regulatory changes or tax structure changes etc.
• Rating Agencies, who are responsible for assigning credit rating to borrower based on analysis of financial information

The author can also be reached at tehsinblog@gmail.com  or http://knowledgekhan.blogspot.in/ 

Note: No part of this article or any article in series is allowed to be copied and share in public (e.g. on any blog or website) without written prior permission of the author in whatsoever manner and, this article strictly meant for Personal use only, not for commercial purpose.