Financial Statement Fraud Detection Model
Enter Financial Statement Data ($)
Provide values for the current and previous fiscal years where requested. Enter '0' if a line item is not applicable.
Income Statement (Current Year)
Balance Sheet (Current Year)
Cash Flow Statement (Current Year)
Income Statement (Previous Year)
Balance Sheet (Previous Year)
Fraud Detection Results
Enter data and click 'Analyze Financials' to see results.
About This Model
This model helps identify potential red flags in financial statements using a set of commonly accepted financial ratios and indicators. It is designed as an initial screening tool and should not be used as the sole basis for concluding fraud. Always consult with financial professionals for in-depth analysis.
**Ratios and Red Flags Explained:**
- **1. Current Ratio:** Measures a company's ability to cover its short-term obligations with its short-term assets. $$ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} $$ **Red Flag:** A ratio significantly less than 1.0 (or below industry average) can indicate liquidity issues, potentially hinting at difficulty in meeting short-term obligations or aggressive accounting.
- **2. Quick Ratio (Acid-Test Ratio):** Similar to the current ratio, but excludes inventory (which may be difficult to convert quickly to cash). $$ \text{Quick Ratio} = \frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}} $$ **Red Flag:** A ratio significantly less than 0.5 (or below industry average) may signal severe liquidity problems, especially if inventory is slow-moving or obsolete.
- **3. Debt-to-Equity Ratio:** Indicates the proportion of equity and debt a company is using to finance its assets. $$ \text{Debt-to-Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Shareholder Equity}} $$ **Red Flag:** A rapid increase year-over-year or an unusually high ratio compared to industry peers might indicate excessive leverage, potentially masking financial instability or aggressive growth financing.
- **4. Gross Profit Margin:** The percentage of revenue left after deducting the cost of goods sold. $$ \text{Gross Profit Margin} = \frac{\text{Revenue} - \text{COGS}}{\text{Revenue}} $$ **Red Flag:** Unexplained significant fluctuations (either unusually high or low) or inconsistent trends compared to competitors can suggest revenue manipulation or improper cost capitalization.
- **5. Net Profit Margin:** The percentage of revenue left after all expenses, including taxes and interest, have been deducted. $$ \text{Net Profit Margin} = \frac{\text{Net Income}}{\text{Revenue}} $$ **Red Flag:** Persistent negative margins, sudden unexplained spikes, or significant divergence from industry norms can indicate earnings management or aggressive revenue recognition.
- **6. Operating Cash Flow to Sales Ratio:** Measures how much cash a company generates from its operations for every dollar of sales. $$ \text{Operating Cash Flow to Sales Ratio} = \frac{\text{Operating Cash Flow}}{\text{Revenue}} $$ **Red Flag:** A declining or negative ratio while net income is positive and growing (or vice versa) is a significant red flag, suggesting earnings are not backed by cash and could be a result of aggressive accounting practices (e.g., premature revenue recognition).
- **7. Sales Growth (Year-over-Year):** Measures the percentage increase or decrease in sales revenue compared to the previous year. $$ \text{Sales Growth} = \frac{\text{Revenue}_{\text{Current Year}} - \text{Revenue}_{\text{Previous Year}}}{\text{Revenue}_{\text{Previous Year}}} $$ **Red Flag:** Unusually high growth (e.g., significantly above industry average without clear strategic reason) might suggest aggressive revenue recognition, while persistent negative growth could indicate business distress or unreported issues.
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**8. Altman Z-Score:** A formula used to predict the probability of a company going bankrupt within two years. While primarily for bankruptcy, a declining score can signal financial distress that may prompt fraudulent activities.
$$ \text{Z-Score} = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E $$
Where:
- $A = \frac{\text{Working Capital}}{\text{Total Assets}}$
- $B = \frac{\text{Retained Earnings}}{\text{Total Assets}}$
- $C = \frac{\text{EBIT}}{\text{Total Assets}}$
- $D = \frac{\text{Market Value of Equity}}{\text{Total Liabilities}}$ (For private companies, Shareholder Equity is often used as a proxy for Market Value of Equity.)
- $E = \frac{\text{Sales}}{\text{Total Assets}}$
- $Z > 2.99$: "Safe" Zone
- $1.81 < Z \le 2.99$: "Grey" Zone (Caution)
- $Z \le 1.81$: "Distress" Zone (High risk of bankruptcy / potential fraud)
**Disclaimer:** This tool provides a basic diagnostic. Financial fraud detection is complex and requires in-depth analysis by qualified professionals. The thresholds for "red flags" are general guidelines and may vary by industry and company specifics.