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An Example of the Limitations of Audited Financial Statements
By Michael C. Dennis, MBA, CBF

Reliable financial information is essential to credit professionals making a decision about whether or not to grant trade credit. Unfortunately, in some cases financial statements can be misleading or even fraudulent. Credit managers often assume that audited financial statements are accurate. The Enron bankruptcy is another in a long list of examples proving that audited financialstatements are not always accurate.

Some credit managers consider an unqualified opinion letter issued by a company's independent auditor as a "clean bill of financial health" for their client company. In reality, an unqualified opinion means that the independent auditors noted no significant variations from generally accepted accounting principles (GAAP) during their audit. What the Enron case demonstrates is that audits are sometimes not as comprehensive as they should be and important information can be overlooked. The role of the independent auditor is to examine the books and records of their client, not to dissect them and not to create them.

In the Enron case, it seems that Enron's independent auditors missed certain financial irregularities. When these irregularities came to light, the value of the stock of the corporation went into virtual freefall, and soon afterward Enron filed for bankruptcy protection. The lessons credit professionals can take from this situation include these:

  • Audited financial statements do not always mean the company is creditworthy.

  • The fact that a company is publicly traded is not a guarantee of creditworthiness.

  • Financial irregularities can occur with audited financial statements

  • If financial irregularities can occur with audited statements, imagine what risks you take when reviewing customers' unaudited statements, or compilations, or internally prepared statements, or fragmentary statements, or financial "highlights".

  • Read the footnotes to look for off balance sheet financing [not that it would have helped in the Enron case to my knowledge].

  • So-called financial experts and rating services and credit bureaus are not always correct in their evaluation of a company.

  • If a customer's financial condition looks too good to be true, it may be too good to be true.

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