… or do they? The role of professional scepticism in our world
Double entry bookkeeping, and the pure bliss of a “world” in balance. For the majority of accountants, there is no source of greater joy than seeing the numbers balance; or frustration when the synergy eludes them. Credit professionals, whilst perhaps not as weirdly obsessed by the numbers, will at least concur that the perfectly reconciled ledger is a “happy place”. But is it true, that the numbers never lie?
In a world where data is the new oil, there is an ever increasing need to maintain a level of professional scepticism in our day-to-day. In this digital age, there is more information available to assess credit worthiness, detect fraud or assess the changing needs of customers. But, sifting through the enormous amounts of data to identify trends, patterns and relationships can require significant time and patience.
Let’s review the following example from a recent insolvency appointment:
Upon undertaking an investigation as part of an external administration of a company, the following facts were presented:
- Year-end accounts for 2016 – 2018:
- recurring reported losses for each period totalling $750K
- significant working capital deficiency – current ratio (current assets/current liabilities) of less than 0.2 for all periods; indicating a lack of liquid assets to meet liabilities as they fell due.
- Balance sheet deficiency of approximately $1M upon appointment
- Realisable assets under $100K
Initial assessment – the company was hopelessly insolvent throughout the period investigated (and likely from incorporation), with potential breaches of directors’ duties under:
- sec 180 – Care and Diligence;
- sec 588G – Insolvent Trading.
However, after a closer look at the financial accounts and creditors list, it was apparent that:
- the company’s business had significant capital start-up costs, which were funded by related parties;
- the overhead structure was largely fixed, limiting the directors ability to scale down the business when forecast sales were not achieved;
- third party creditors equated for a combined total of 8% of the deficiency;
- the appointment crystallised contingent lease liabilities amounting to 12% of the deficiency;
- the remaining 80% of the deficiency was liabilities to related parties that had provided financial support to the company since inception;
- once the related party financial support was withdrawn, the directors appointed an external administrator immediately;
- the total third party creditor claims equated to less than one month’s costs of goods sold
Subsequent assessment – whilst clearly insolvent but for the support from the group, the conduct of the directors was unlikely to breach the obligations of sec 180 or sec 588G.
The purpose of considering this example is to demonstrate the need for further scrutiny of the facts to determine the truth behind the information being presented. Often the data can present contradictory information and it is incumbent on us to bring a questioning mind to these anomalies to discover the truth. A reliance on manicured reports without an understanding of the source of the information is fraught with danger.
In a further example, recently we viewed a credit agency report on a company, which showed:
- the company had been incorporated and registered for GST for over 2 years
- there had been numerous credit enquiries made during that period
- there were no court actions
- there were no payment defaults
- the credit score was in the “low risk” range
Initial assessment – there are no red flags to suggest that the company was not worthy of further consideration for credit terms.
Upon closer assessment, it was discovered:
- the company had not traded during the preceding two years;
- the company did not have any assets
- the company had no working capital
- the company was utilising a related entity, with a very similar name, to demonstrate a trading history
Further assessment – a further investigation into the “group”; consideration of guarantees; reassessment of credit terms and limits.
This example demonstrates two elements where a misunderstanding can arise. A “clean skin” start-up does not necessarily mean that the company has only recently been incorporated. A reliance on credit scores alone for a company, even one that appears to have been trading for over two years may not “arm” you with all the facts. And secondly, the digital world can be a world of “smoke and mirrors”. Finding a website, with a similar name and address, does not necessarily mean that it belongs to the company or forms a part of its business operations.
In the fast moving, data rich environment of business today, sometimes we need to embrace our inner accountant (as scary as that may be) and bring our professional scepticism to the fore. “If the itch is there, scratch it” … speak with your customers, peers and advisors so that you can see the full picture when making recommendations or decisions.