Spotting the Signs Part 4: The SME Angle (Minimizing Profit?) ("中小企篇")

TL;DR: This final installment looks at financial manipulation specific to Small and Medium Enterprises (SMEs). Unlike listed companies often trying to inflate profits, SMEs frequently aim for the opposite: reducing reported profits to minimize tax obligations (unless planning an IPO or sale). Tactics include excessive employee cash advances, large cash expenses, hiding investments as costs, accelerating depreciation, inflating benefits or bad debt provisions, and overstating expenses like WFH or travel. Understanding these "downward" manipulations is key when assessing SME financials.

(Final Disclaimer Reminder: This series is purely for educational awareness to help you identify potential red flags. It is not a guide for committing fraud, nor a substitute for professional forensic accounting when serious concerns arise.)

Hi everyone, James here for our concluding piece on understanding potential financial manipulation.

We've previously discussed tactics used, often by larger or listed companies, to artificially inflate profits – driven by stock prices, bonuses, or M&A ambitions. However, when looking at Small and Medium Enterprises (SMEs), the incentives often work in the opposite direction.

Unless an SME is actively preparing for an Initial Public Offering (IPO) or a sale (where making the books look "pretty" is important), the primary goal is frequently tax minimization. This means the manipulation, if it occurs, aims to reduce reported profits as much as possible within (or sometimes beyond) legal limits.

So, when analyzing SME financials, we often need to invert the logic used for spotting inflated profits. Here are some common tactics SMEs might employ to understate their earnings:

Common Tactics for Reducing SME Profits:

1. Excessive Employee Expense Advances: It's normal for employees to take small advances for upcoming expenses ("Expense/Sundry Cash"). However, it's abnormal if the total amount advanced across all employees is large enough to cover significant operational costs (the example suggests three months' worth). This could be a way to park company cash off the books temporarily or to facilitate inflated expense claims.
2. Over-reliance on Cash Payments for Expenses: While some cash transactions are normal, paying the vast majority of business expenses in cash makes auditing difficult and can facilitate the under-reporting of income (if cash sales aren't banked) or the overstatement of cash expenses.
3. Disguising Investments as Expenses: An SME might invest in another company or project using materials, resources, or direct funds, but instead of recording this as a "Long-Term Investment" asset, they might improperly classify the outflow as a current cost or expense. This hides assets off the balance sheet and immediately reduces profit.
4. Accelerated Depreciation / Immediate Expensing: Instead of depreciating assets like computers or equipment over their useful lifespan (e.g., 3 years), an SME might expense the entire cost immediately in the year of purchase. This artificially lowers profit in the current year by pulling forward future depreciation expenses.
5. Inflating Employee Benefits into Production Costs: While enhancing employee benefits is positive, classifying excessively inflated or vaguely defined benefits directly as production costs (Cost of Goods Sold) can improperly reduce gross profit margins, making the core business appear less profitable than it is.
6. Excessive Bad Debt Provisions: Creating an overly pessimistic allowance for doubtful accounts ("bad debt provision") results in a larger expense being recorded, directly reducing reported profit. This needs to be reasonable based on actual collection experience.
7. (Overstated) Work-From-Home (WFH) Expenses: With the rise of remote work, there's potential to claim excessive or poorly documented expenses related to WFH setups or ongoing costs.
8. (Overstated) Transportation Expenses: Similar to WFH, travel and transportation expenses can be inflated or lack sufficient documentation, reducing taxable income.

Easier to Deflate Than Inflate?

Looking at these common SME tactics leads to an interesting observation: "做低竟然容易過做高！"  It often seems easier to manipulate profits downward than upward. Inflating profits requires creating complex fake revenue streams and dealing with ballooning receivables (as discussed in Part 2). Reducing profits often involves accelerating legitimate expenses, being overly conservative with provisions, or exploiting poorly controlled expense categories.

This highlights the critical importance of strong internal controls and thorough scrutiny even in smaller organizations.

好孩子不要學系列：「如何識穿做數：中小企篇」

//本系列會說明一些常見的「做數」方法，但目的並非叫你學會「做數」，呢啲事留番俾受過訓練的專業人士就好。相反，這系列是為了讓你更有能力去發現舞弊的「蛛絲馬跡」。//

中小企除非諗住上市（要做靚本數簿），一般做法係以避免交稅為大前提，所以係盡量減少財務報表嘅盈利。

用前三篇嘅方法可以去整理一下。（大方向倒轉）

1. 「員工借Expense/ Sundry Cash 正常。但所有員工加埋可以支付公司三個月營運開支就不正常。」
2. 「現金交易正常。但用現金支付大部份開支費用就不正常。」
3. 「以材料物資/ 費用成本的方式，向其他公司進行投資時，不反映在「長期投資」會計科目中，而把投資列入成本、費用項目中。」
4. 「提前攤銷支出；例如電腦可以分3年Depreciation; 直接當開支。」
5. 「合理提高員工福利直接變成生產成本。」
6. 「提高壞帳率及壞帳準備金。」
7. 「WFH 開支。」
8. 「交通開支。」

你睇？做低竟然容易過做高！

This concludes our "Spotting the Signs" series. Whether dealing with large corporations potentially inflating profits or SMEs potentially minimizing them, the core principle remains the same: approach financial information with a critical, informed eye. Understand the motivations, look for anomalies, ask questions, and never stop learning. Financial literacy and diligence are essential tools for anyone involved in business. Stay sharp and ethical.