USASBE 2008 Proceedings - Page 0569
Due diligence is always important in business but especially so across borders where the entrepreneur has no experience with the culture. This is especially true of China, where a shortage of trained accountants exists. In this case, the reliability of reported financial information can and should be improved by a properly conducted audit by independent auditors.
In the absence of an audit (during interim periods) stakeholders can use the relationships between accounts reported in the balance sheet, income statement, and statement of cash flows compared to industry averages (ratio analysis) to establish a sense of the degree of reliability contained in the statements.
Following is an example of ratio analysis using cash flows from operating activities:
If the Income Statement reported sales of US $100,000 and the Balance Sheet indicated that accounts receivable increased US $40,000, then the reader would expect to find an inflow of cash on the Statement of Cash Flows of US $60,000.
If the Income Statement reported the cost of goods sold to be US $50,000, and the Balance Sheet indicated an increase in inventory during the reporting period of US $20,000US, then the reader would expect to find an outflow of cash of US $70,000 to suppliers on the Statement of Cash Flows.
If the Income Statement reported operating expenses of US $30,000 and the Balance Sheet indicated that accounts payable decreased US $10,000 during the reporting period, then the reader would expect to find an outflow of cash of US $40,000 for operating expenses on the Statement of Cash Flows.
Also, cash flows from investing activities could follow this scenario: If the Balance Sheet indicated an increase in the cost of Property, Plant, and Equipment during the reporting period of US $10,000, the reader would expect to find an outflow of cash of US $10,000 for the purchase of equipment on the Statement of Cash Flows.
Additionally, cash flows from financing activities would have to follow this scenario if no other activities occurred to explain the change in the cash balance during the reporting period:
If the Balance Sheet at the beginning of the reporting period indicated a cash balance of US $10,000 and management decided they wanted to have a US $20,000 balance on hand at the end of the period, then the reader would expect to find an increase in debt (or some other financing arrangement) of US $70,000. The US $70,000 increase in debt is the result of: