Lean back in your chair, take a deep breath, and think “accountant.” What comes to mind? Do you see a humorless, taciturn man with a wiry build peering over spectacles at ledger books? You’re not alone.

That’s the image most of us still conjure up when we think of that person we hire when we need our taxes done or our books cleaned up.

Today, though, that image is changing. A new breed of accountants is emerging, one that is arguably more exciting. This new type of accountant is only part numbers expert. The other part: detective.

Enter the forensic accountant – a professional trained not only to look ‘at’ numbers but ‘beyond’ them. Forensic accounting merges investigative skills with accounting expertise.

This can be a valuable merger, especially for an independent tire dealer. Behind the black and white of balance sheets and income statements are trends and patterns that can help build a dealer’s business. And, it’s the forensic accountant’s job to uncover them.

Like detectives, forensic accountants have to be detached. That’s why it’s often helpful for an independent dealer to hire an outsider who can look at the business objectively, according to Richard Lipton, president and founder of Richard L. Lipton CPA & Associates. “Business owners can sometimes be too close to the business,” he says.

Lipton’s accounting and consulting firm, located in Morris Plains, N.J., draws on its founder’s 10 years as a stockholder and manager of family-owned Sam’s Tire Co. in Patterson, N.J.

Accurate Records, Reliable Clues

Lipton has helped several independent tire dealers throughout the U.S. uncover hidden opportunities for bottom-line gains. With all of them, his first step is confirming that financial records are accurate. Balance sheets and income statements, in particular, must be accurate and complete for an investigation to have value.

Why? Because without evidence, detectives can’t piece together a mystery. And without accurate and complete financial records, forensic accountants can’t uncover hidden problems or opportunities in a business.

“Without good records, it is impossible to determine the financial condition or profitability of a business,” says Lipton. The specific records a company needs depend on a number of factors, he says. But, in general, a small business such as an independent tire dealership needs to keep the following: a basic journal of transactions (including receipts, disbursements, sales, purchases, etc.) and accounts receivable, accounts payable, payroll records, petty cash and inventory records, says Lipton.

“That’s where we’re going to start for our investigation and ultimately for our decision making,” Lipton explains. “The bookkeeping and accounting system should revolve around the business.” Sometimes, adjustments are necessary to ensure that the numbers accurately reflect business operations. For example, Lipton will calculate a dealer’s proper gross profit margin or the method of depreciation most applicable to the business.

Surface Investigation

After Lipton confirms that the books are complete and accurate, he then begins to analyze them. Lipton starts with the income statement (bottom-line earnings), which affects the balance sheet (what the company is worth).

“I always first look at the bottom line,” he explains. “Is the dealer making or losing money and why? Should the dealer be more profitable?”

To answer those critical questions, Lipton uses proprietary industry benchmarks he has been developing for years. “Our business valuations provide us with valuable data, such as ratios and percentages, from different geographic areas that we can use to analyze the business,” he says.

But a business is much more than its books, and Lipton takes that into account. “We start with the paper. Then, we speak to the owner to help understand the operations of the company.” That way, Lipton can apply industry benchmarks to the individual business to determine if any numbers are out of line. In other words, Lipton massages general industry benchmarks to match the individual intricacies of a specific dealership operation.

For example, if gross profit margin is too low, pricing structure should be carefully reviewed and analyzed. But, if profit margin is unusually high, the cause may be specialty or private brands, which generally yield better margins, Lipton explains.

“We can’t just go by benchmark percentages,” Lipton insists. “We have to dig into it and determine what they are doing and why.”

Like a private investigator, Lipton looks at the evidence and uncovers telltale clues of potential problems. At the same time, he searches deep within the financials for opportunities to improve bottom-line profit.

Digging Deep: Exposing the Sinister

One of the most common clues Lipton uncovers while working with independent tire dealers is low margins. Rising expenses, declining revenue, reduced cash flow, excessive debt, high inventory shrinkage and unfamiliar vendors are other signs that something is amiss. He digs deeper to discover the causes.

And those causes, once uncovered, can be surprising. “Most people believe that the obvious cause for low margins is not charging enough or paying too much for product,” Lipton explains. “But that’s not necessarily the case. If profit margins are too low, one of several things could be happening,” he says. Those include inventory pilferage, receivables theft, employee embezzlement or other types of fraud.

With fraud, it’s dangerous for tire dealers to take an ‘it-won’t-happen-to-me’ attitude. Of course, dealers want to trust their employees. And small organizations tend to develop a family-type atmosphere; everyone’s on the honor system. But the sad truth is that fraud is more common than independent tire dealers think. In fact, statistics show that employee fraud is more common in small businesses than in Enron-sized organizations.

In its 2004 Report to the Nation on Occupational Fraud and Abuse, the Association of Certified Fraud Examiners (ACFE) reported that small businesses (employing fewer than 100 people) suffer disproportionately large losses from occupational fraud and abuse. The report, based on more than 500 occupational fraud cases, concluded that the impact of fraud is much greater on small businesses than on larger companies.

According to the study, small companies suffer a median loss of $98,000 from fraud. “This was higher than the median loss experienced by all but the very largest organizations,” wrote the ACFE. Additionally, about 46% of the frauds reported in the study attacked small businesses.

Furthermore, a recent report states that per-employee losses from fraud in small businesses are 100 times greater than those at their largest competitors.

This disturbing yet generalized data is backed up by specific, anecdotal evidence revealed by tire dealers. For example, one anonymous dealer tells a story about an ex-employee placing new tires in waste receptacles along with worn, discarded tires. Later, an accomplice removes the new tires from the garbage and sells them.

Lipton also tells of instances in which road-service truck drivers assist non-customers on their own and simply pocket the money. He’s also discovered employees secretly writing off receivables and keeping the cash.

Whether due to inadequate employee screening, a low-quality labor pool or limited controls, employee fraud happens. And, dealers can’t afford to ignore it.

“On average, 20% of business income is lost due to fraud,” says Lipton. “Fraud is something dealers need to look at, and that’s something that doesn’t come up in everyday accounting.” As might be expected, fraud occurs most frequently in dealerships that don’t conduct regular financial audits.

Detecting fraud with accounting methods is where the real sleuthing begins. There are literally thousands of signs of potential workplace fraud. It’s up to the forensic accountant to identify and expose them.

Recognizing the common warning signs of fraud early can help businesses reduce losses or avoid them altogether. Some of the most common fraud indicators include rising expenses, declining revenue and abnormally high inventory shrinkage. Other, more specific, red flags include unaccounted purchase order numbers or missing purchase orders; dramatic increases in labor costs or overtime not justified by a sales increase; increased payments to a vendor for no apparent reason; consistent cash shortages; excessive numbers of voided sales transactions; and excessive inventory write-offs, among others.

Depending on the kind of fraud suspected, the financial detective will begin collecting evidence that will ultimately uncover and put an end to the fraud. For example, if inventory theft is suspected, Lipton will conduct surveillance, recommend establishing time tickets or count supplies regularly.

Digging Deeper: Trend Analysis

Though fraud is a serious concern – possibly resulting in the complete unraveling of an independent tire dealership – not all forensic accounting is about uncovering sinister activities. An investigation into a dealership’s financial records can also detect inconsistencies that, when corrected, can unlock additional profit potential.

When looking at balance, income or cash-flow statements, a forensic accountant looks for unusual changes from year to year. An investigative accountant, for example, looks at income statements to determine if net sales or operating revenues are increasing over time. If so, he looks deeper to determine if they increased faster than the previous year or faster than the rate of inflation. When looking at cash-flow statements, this special kind of accountant will determine whether cash has been increasing or decreasing over the years.

Then, he asks questions such as: Do any of the numbers seem out of line? Has cash declined because the owner invested in capital equipment? Or, is something more ominous occurring?

According to Lipton, failure to plan and analyze cash flow is one of the leading causes of small business failures. Solid, positive cash flow is essential to the survival of any business, he insists.

Analyzing cash flow with a forensic eye should reveal whether daily operations generate enough cash to meet obligations. It should also show how major outflows of cash (to pay expenses) relate to major inflows of cash (from sales), Lipton explains.

Significant changes over time will also appear under a forensic accountant’s magnifying glass. With the help of an investigative accountant, a tire dealer will be able to tell if inflows and outflows combine to result in a positive cash flow or a net drain, Lipton says.

When cash-flow deficiencies are found, financial plans must be altered to provide more cash, advises Lipton. “When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested,” he adds. “The objective is to develop a plan that will provide a well-balanced cash flow.”

Many strategies for balancing cash flow exist. Collecting receivables, tightening credit requirements, adjusting pricing, taking out short-term loans, increasing sales and managing expenses are just a few ways to boost cash flow, according to Lipton.

Reducing costs, too, can be done in a variety of ways. The most obvious cost-cutting methods, according to Lipton, include staff reduction, elimination of overtime and delaying of purchases. However, hidden costs can also be uncovered and reduced by analyzing and rethinking insurance coverage or modernizing billing systems.

Deeper Still: Operational Issues

Examining financial data can also detect operational problems, such as overpaying vendors, inadequate pricing, or payroll problems.

“Payroll is not like inventory,” Lipton says. “If you have too much inventory, a lot of times, the supplier will take it back. If you have too much payroll, you can’t get a refund. But, if you don’t have enough, you can’t service your customers.”

As during the surface investigation, Lipton again looks at industry benchmarks and asks the dealer questions about the business. If payroll is not at the right proportion to revenues and expenses, Lipton searches for causes.

“I have found that some tire dealers have too many people,” Lipton explains. “Nobody could work efficiently because employees were getting in each other’s way.” Other dealers don’t have enough workers to handle customer traffic, and sales drop as a result.

If Lipton suspects that payroll numbers are off, he helps the tire dealer determine the ideal number of employees and hours they should work. “I have been in situations where we cut back on the amount of employees, and the lower number of employees increased sales,” says Lipton.

Additionally, Lipton looks at a dealership’s growth statistics to determine if they are healthy. And, slow or nonexistent growth is not always the red flag that something is wrong. “Most of the bankruptcies we see in our office came from uncontrolled growth,” Lipton says. “They grew too quickly.”

If a tire dealer is renting commercial space, Lipton looks at rent figures. A dealer with a net lease, for example, is billed a standard amount each month, plus any increase in expenses the landlord has experienced. It’s known as a base-up charge. “If real estate taxes increased 5%, the landlord can bill the increase back to the tenant. It’s a way landlords protect themselves in long-term leases,” explains Lipton.

Lipton examines base-up charges to see if they’re on par. “Based on benchmarks and further investigation, we determine if these figures seem right,” Lipton explains. “If not, we work on getting a refund from the landlord.”

The forensic accountant’s job doesn’t end there. Once Lipton discovers a problem and works with the dealer to solve it, he’ll then put controls in place to prevent future occurrences.

“Regardless of which problems we’ve uncovered, we put into place a system to minimize the possibility of them happening again,” he says.

Though interesting and potentially very lucrative, forensic accounting is not an activity for the uninformed. Even self-proclaimed financial gurus can make dangerous missteps without the aid of a professional. Trends can be misread; numbers can be skewed. The result: inaccurate data, false conclusions and wasted time. That’s why tire dealers should not attempt forensic accounting without an expert, Lipton warns.

Even then, dealers should still approach financial adjustments with caution. “Don’t make a rash decision without taking all of the individual factors into consideration,” he advises.

“You may want to dim the lights a bit, but don’t shut the lights off completely. If you do, you won’t see where you’re going, and you’ll be out of business.”

Richard Lipton can be reached at 973-292-9252 or through www.liptoncpa.com.