Managing Directors (also known as Chief Executive Officers), control the operations of a company and are expected to know every detail of the company's performance.
The chief Financial Officer, (also known as Finance Director),is saddled with the responsibility of making the financial results available to the Managing Director periodically .
Companies, by law, are required to engage the services of an external Auditor, to express a view on the financial results yearly for presentation to the shareholders, at the Annual General Meeting.
In a growing number of instances, the financial statements are inaccurate, and therefore mislead investors, shareholders and other stakeholders on the financial health of the business by overstating their profits. Should we always hold the MD/CEO responsible?
This issue is examined in this first discussion on this website. We welcome your comments and reactions
Most companies institute very strict internal controls to safeguard their assets and the running of their companies against abuse and mismanagement. While the attention is on abuse through frauds, mismanagements etc., which results in reduction of assets and the ultimate effect on the companies profits, activities where the profits are deliberately overstated have just began to attract serious attention in Nigeria
One can understand the advantages of understated profits. Once upon a time, Companies declared less than actual profits which led to payment of lower taxes, after which company Shareholders and Directors shared undisclosed profits.
In many cases, the Tax authorities would write queries and try to dispute the stated profits so as to extract more money for Government. This prompted the Government to impose minimum criteria for assessing tax payable, based on a percentage of turnover, a percentage of share capital or profits, whichever is highest
These days we now see instances where companies overstate their profits and even pay taxes and sometimes dividends just to support the false claims.
When profits are overstated, the MD/CEO is not usually absolved of blame. Whereas, when frauds are committed, he/she only carries the responsibility, but not necessarily the blame, depending on the outcome of an investigation.
Nigerian MD/CEOs of conglomerates and multinational companies usually go through a long period of training, first as Trainee managers, and then numerous management short courses while they head departments. Alternatively, those hired from outside are seasoned administrators with high flying CVs. In all cases, personal character and integrity are always well verified (people with previous criminal conviction or doubtful records are barred by law). Even in cases where a founding MD/CEO of a smaller company acquires a conglomerate and becomes the MD/CEO of the merged company, he/she is usually a very skilled manager. One can understand why public opinion is always against the MD/CEOs of such companies involved in this practice.
This topic therefore examines this issue of companies issuing misleading reports and tries to see to what level the MD/CEOs can be an accomplice. A clear understanding can be of great benefit to the business community, and the steps a company and its MD/CEO can take to prevent this situation.
To limit the reason for overstating company profits to the influence of interested parties (which includes the MD/CEO) when it involves issuing dividends and a price appreciation of the value of the stock will amount to over simplification.
We may want to know other reasons why the profits in a Company may be overstated.
An attempt to cover up a larger fraud,
An attempt by a department head to avoid blame or sanctions for oversights,
an attempt to avoid an appropriate reform, which might result in losses of jobs and positions being made redundant, especially when it affects the people concerned.
Sectional heads usually want to attract higher budgetary allocations and may disguise the true position of things to justify this.
To secure more bonuses, if assessed on profits,
To strengthen a departmental head's position in board room politics, especially when, or if the position of the Chief Executive (MD/CEO) becomes vacant.
To make a company more attractive to external investors, especially when an Initial Public Offering or outright sale is imminent.
The suggestion that the MD/CEO would not be involved in the publishing of misleading financial reports may be inconceivable. However, when examining some of the reasons stated above, we may not entirely discount some degree of innocence in some cases.
Morover, the activities of different sections may contribute to the declaration of
higher than actual profits, which could be difficult to unravel, especially if the sections are self accounting
(presence of a sectional accounts section which reports to the sectional head, who may exert some influence on the sectional accountant).
The stock market, in most third world countries including Nigeria, still forms a small part of the activities of the Gross Domestic Product, as most businesses are still owned by sole traders, family or by a small circle of friends.
The small and tight structure of the business affords the owners a considerable insight into the activities, by just asking some questions and looking into the bank accounts. We all know that this does not give a fool proof account of activities hence the publishing of financial statements.
The situation becomes more complex when we consider companies with an extensive manufacturing, trading and/or retailing operations which in some cases might have involved several mergers and acquisitions, and may span several locations. As these small businesses expand or grow, the ability to gain this quick insight is gradually lost.
Preparation of many accounting statements becomes inevitable which many entrepreneurs find difficult to comprehend fully. By the time these companies qualify to go to the capital market, and abide by the strict regulations required of listed companies, the preparation and discussion of the financial statements become such a stressful ritual that the original effectiveness and efficiency of the company may be lost if no major reorganization takes place. The company now transforms to a stage where several departments are created and levels of responsibilities delegated among the several managers of these departments.
The MD/CEO will now be required to coordinate and manage the activities of these managers.
Very few Nigerians, compared to the number of businesses in the Country have ever managed such big businesses.
Real experience in this area therefore is not as widespread as a formal education in Business Management or Administration.
So, I do not believe that most of the journalists, regulators, and even those we normally refer to as "Business Moguls" are really qualified to issue the types of condemnations we have seen in these cases. We must not generalise unfairly.
A system of internal audits, combined with regular audits by external auditors can prevent this type of abuse. However, we must not forget land mark cases where investors have sued external auditors for losses stemming from confirmation of inaccurate financial statements. Internal audits actually do a lot in preventing transaction frauds. In fact, many software packages do this automatically, either as stand alone, or embedded into the accounting software utilised.
They may however not be effective in pre and post transaction frauds. (Pre transaction frauds are conceived and implemented for the sole purpose of defrauding a business, while post transaction frauds are scenarios created deliberately to make or induce management, or even a board, to make a decision which eventually turns out to be a hoax. In both cases, they pass through the normal processes without detection).
These are usually carried out with the connivance of some highly placed employees/staff/managers, who sometimes establish fictitious clients and customers, exploit their knowledge of the company's internal workings and culture, and then carry out transactions which would pass as normal without any suspicion.
While a lot of emphasis is placed on actions which can result in immediate loss of assets, not much has been placed on schemes designed to deceive management on the true financial health of the company for the reasons stated earlier. By the time management of a public company realizes the true situation, it will require tremendous courage to notify the Stock Exchange, Shareholders, other relevant regulatory bodies and those who have an interest in its performance.
A company relies so heavily only on figures presented by the Finance Director, who in turn, may also rely heavily on an "efficient accountant". Statutory provisions in the Companies and Allied Matters Act require books of accounts to be audited annually by external auditors. This however is done only once a year, and information is not available for regular internal review of the company's performance.
External Auditors and the staff of the Accounts Department belong to the same profession. The latter therefore know how to disguise or conceal discrepancies successfully, as they understand what can arouse their colleagues' suspicion, especially if the same firm has been engaged as external auditors over a period of time.
The Internal Audit department is usually under the control of the Finance Director/CFO. This could compromise its objectivity.
A management decision taken either to expense or capitalize graft. It is not uncommon in third World countries for some companies to pay a lot of money to some influential officials/persons to secure some strategic advantages or favors. The benefits of these advantages, in their own opinion, may extend over a number of years. If this fails for any reason, the company will then have to decide how to write down such expense without raising any attention from the public. When this comes to light, the MD/CEO becomes the culprit.
Outsourcing
Many companies now out source some of their normal operations, such as the Human Resource department. Some even outsource a whole accounting department. The advantages are obvious if the companies managing these outsourcings are very reliable. There is however a new set of problems. Auditing, for example should not be done by the same company handling the accounts. Confidentiality is compromised among too many out sourced operations. This is very crucial if the same firm handles those of competing businesses.
Online Information Systems. Advances in Information Technology have made computer hardware and software increasingly more sophisticated and cheaper by the day. It is now possible for different departmental heads and the MD/CEO to view company position in real time from a laptop computer even from remote locations. These days, some smart phones can act as terminals, and management is kept informed of developments promptly and has enough time to make appropriate decisions.
Online Banking Systems . Most Nigerian banks now offer services where companies get e-mail or SMS alerts on their mobile phones whenever a transaction takes place. Bank statements are sent at regular intervals to e-mail addresses specified. So, information can be made available promptly and simultaneously to the CEO and the relevant departments, affording them an opportunity to view the statements.
They must use ratios, based on past activities: e.g.. Production to sales; Total production costs to overall costs; debtors to sales; purchases to creditors and as many others that give you a not only a deeper insight, but also reports unusual performance.
These must be evaluated and modified from time to time. Don't share the secrets of these ratios with any other staff.
Just demand an investigation when ratios fall out of expectation without disclosing the real reason for the investigation. This should be the case, whether they are favorable or not.
Avoid distractions. There are many "National Assignments" Industry assignments, Keynote addresses that advertise a company. The CEO must manage these with the time available for managing the company. Dishonest staff can easily capitalize on these assignments to perpetrate frauds.
Not be unduly elated by reports of outstanding performance. Make sure the reports are justified by the net current assets, especially the bank balances. Changes in their positions between the opening and closing periods provide very valuable guides.
Must ensure there are no secret creditors. You must take time to go through the purchases of goods utilized during the year, to see that it tallies with the records of those paid and those yet to be paid. The same should go for the sales to be sure the debtors are real. These should be verified by the auditors.
Not encourage the employing staff based on recommendations from associated persons (creditors, customers, suppliers etc. or even Directors and major shareholders) and avoid having many employees with same referees. This could give rise to a parallel management structure unknown to the CEO which may compromise his/her control on staff to the advantage of some other persons.
Avoid populating a department/unit with too many people of the same tribe/clan. This may also compromise loyalty, just as with the last point.
Ensure that the periodical financial reports are completed early, go through them and their implications fully understood. The annual reports must reflect the totality of the periodic financial reports. Discourage practices where separate reports are produced for external auditors. Where this is not practicable (due to disclosure requirements) a reconciliation statement must be produced.
Organize regular brain storming sessions with the various departments on ways to stem fraud and fraudulent activities, with and without the internal auditors, just the same way as regular symposia, workshops etc., are held for marketers, customer relation officers and others.
Ensure that the reports are produced in electronic form so they can be visualized as graphs. Investigate and observe patterns. Performances which show straight horizontal lines need further analysis, as “there are no straight lines in nature”. (There are many software solutions in the market capable of analyzing practically any conceivable data. The question is: are the correct figures keyed in?)
Should avoid using company facilities for private engagements like marriages, burial ceremonies and birthday parties (very important activities in Nigerian cultures).
Some staff will enslave the CEO through these occasions, just as well as knowledge of the CEO's dark side (undesirable personal habits). They can then undermine his/her authority to their advantage.
Must insist on clear documentation of every Board decision and must keep accurate records of such independently. Unfortunately, the MD/CEO hardly escapes sanctions if the entire board is indicted, unless he can prove that it was carried out without his consent.
Company policy must ensure the independence of internal auditors. They should not report only to the Finance Director, but also the MD/CEO, and others the company will decide from time to time. There should also be a second external auditor who should be engaged infrequently to check various sections in a sporadic manner.
In addition to these, Legislation is required to
Discourage the practice of issuing dividends based on interim unaudited results. Dividends should be issued only on confirmation of financial health of a company.
Dividends issued by any company should be limited to its liquidity position.
It can be seen that these precautions will also go a long way in preventing frauds in companies of any size. Overstatement of profits in itself is a form of fraud. Dividends may be issued by a company which may not be in a position to do so, just the same way as money is embezzled by an official. In both cases, the net assets value is fraudulently reduced.
In most third world countries, like Nigeria, where income gaps between the rich and the poor can be very wide, the MD/CEO of a very large company is regarded as very privileged as his/her salary alone is usually more than the total incomes of most businesses.
As such big companies are not in abundance in a third world country, there are therefore thousands who may compromise their integrity to get the job, or see their cronies there. The bigger a company, the more intense internal politics become.
This is not to say that MD/CEOs should behave like paranoia patients. All the "sins" that may lead to their downfall may not be of their own making. The watchword is "CAUTION".
