What is important to check first?
A man named Eddie M. (his real name was changed to preserve the confidentiality of the client) was buying a gas station. There was no Point Of Sale system in this business.
In other words, every transaction went through the checkout.
At the same time, there was also a shop and a small restaurant in the gas station. This means that there were a huge number of transactions.
The grandmother, the owner of the business, neatly put the primary documentation in boxes and sent it to the CPA, who made the reports. She kept tapes from all of the cash registers at home. At the time of the due diligence, there was a 20-foot container in the backyard of the house that was completely stuffed with ribbons.
Upon review, it was striking that in some months the profit jumped sharply upwards. As it turned out, this was because the CPA was losing data about purchases.
The lost data caused revenue to fluctuate. The buyer said: "Let's take the primary documentation and restore everything." The grandmother was indignant. As a result, they decided to take data for only a month, although this was also a huge amount of work.
It took a week to enter all the data into the table. Then they asked to compare the new information with the fact that the grandmother poisoned the CPA.
Noticeable errors were found. The girls who entered all the accounting data made numerous mistakes.
Luckily for the buyer, he pulled out of the contract, saying the business was unprofitable.
When the grandmother (business owner) found out about what was happening, she was furious. It didn’t go well for everyone. The CPA also began to have troubles because he had overestimated the profit, and the grandmother paid huge unnecessary taxes. She had to hire lawyers to deal with it, and she paid them too.
What are the reasons for these discrepancies? Two plots are possible: either the accounting is carried out in a third-party organization and is focused only on tax reports, or an incompetent person is engaged in maintaining it.
Typical mistakes made in bookkeeping.
- CPAs usually conduct accounting once a quarter. Documents are brought to them in a box. The CPA puts them somewhere in a corner. His attitude is: "When there is time, then we'll do it." Some of the documents will disappear during the quarter, they are overlooked, or something else happens. The CPA may lose a part. The rest of the documentation is brought not by an accountant, but by a girl who only answers the phone and doesn`t understand accounting programs.
It is implied that CPAs should do this, but they don`t. As a result, several layers of errors are created.
The classic situation: the company receives a loan; the girl mistakenly records it as revenue. The owner doesn`t review her work and doesn`t know what is going on in his documentation.
- People who do bookkeeping tend to cut corners to simplify their lives. Instead of entering separate transactions, they write a total sum once a month.
To solve these accounting problems, you need to get primary documents. First, acquire the business bank statements. Second, collect invoices from suppliers. In a restaurant, this is a tool for determining real revenue.
The owner says that “$1 million a year passes through the bank. But there is a lot of cash in this business that I put in my pocket. That makes about $1.5 million.” The formula for calculating revenue: the cost of purchasing food should be 30-35% of the revenue. If you have revenue of a million dollars that went through the bank and invoices for $350 thousand, then the purchase amount should be more than $500 thousand if you believe the dreamer owner. However, this is not the case. Likewise, in the construction business.
Read more about how to check your tax documents here.
- Payroll wages. Here, it is especially important to pay attention to the correspondence between the list of employees, written in the owner’s hand, to the list where the salary for each employee is indicated. This way you can identify who is being paid “under the table” or undocumented immigrants. Moreover, wages are an indirect indicator of the true amount of profit. Read more about employee verification in our article.
You can learn more about how a business audit should be conducted in our class.
What you need to know about accounting:
- In accounting reports (P&L, balance report) you can only trust the page number. Everything else needs to be checked.
- All assurances that cash flows occur outside of bank deposits should be ignored. This is never confirmed.
- The owners are modestly silent about undocumented immigrants. This must be brought to light with particular ferocity.
- If you are not an experienced auditor, you will not be able to do it correctly on your own. To conduct a quality check, you should involve professionals. Read more in the article "Who checks the business".