A Practical Guide to Forensic Accounting for Indian Stocks

Forensic accounting, applied to a listed company, is the practical work of testing what the reported numbers are actually made of instead of taking the headline at face value. In practice it comes down to a short list of repeatable checks: does profit turn into cash, are receivables and inventory growing faster than sales, how is revenue being recognised, who are the related parties, and what are the auditor and the promoter quietly signalling. This guide is the how-to version of that discipline, a checklist of techniques you can run on any Indian company from its own public filings.

The point is not to prove a company is dishonest. Most are not. The point is that a reported profit figure is a conclusion built from dozens of judgement calls, and forensic checks are how you decide whether to trust it. Indian corporate history has its documented accounting failures, the Satyam episode of 2009 being the most famous resolved case, and in almost every such story the strain was visible in the filings well before it reached the price. The techniques below are how you look.

Start where cash and profit disagree

The first and most valuable check is the relationship between reported profit and the cash the business actually generated. Profit is an opinion shaped by choices on depreciation, revenue timing, and provisions. Cash in the bank is a fact. When the two drift apart, you have a thread to pull.

The simplest version is the ratio of operating cash flow to reported profit after tax, tracked over five years or more rather than a single year. If a company reports rising profit year after year while operating cash flow lags well behind, the blunt forensic question is: where did the cash go. Sometimes the answer is entirely benign, a fast-growing business tying up cash in inventory and receivables as it expands. Sometimes it is not. The check does not tell you which. It tells you to go and find out. The distinction between a healthy gap and a worrying one is exactly what free cash flow versus net profit is built to explain.

Two practical habits make this check sharper. First, look at the trend, not one year, because a single weak conversion year can be seasonal or a one-off working capital swing. Second, when cash lags profit, open the cash flow statement’s working capital section and read which line moved. That is usually where the answer is sitting.

Read the receivables and inventory build

Working capital is where a lot of the cash-versus-profit story actually lives, so it earns its own set of checks. The two lines to watch hardest are receivables, the money customers owe, and inventory, the unsold stock. The forensic technique is not to look at their size but at their pace relative to sales.

Run three quick comparisons over several years:

• Receivables growth versus revenue growth. If receivables are consistently growing faster than sales, the company may be booking revenue it has not collected, or loosening credit terms to push volume. A rising number of days of sales stuck in receivables is the warning.
• Inventory growth versus revenue growth. Inventory piling up faster than the business grows can mean stock is not selling, or it can mean a deliberate build ahead of a strong season. Both are possible, so you read management’s commentary before you judge.
• The cash conversion cycle over time. This ties receivables, inventory, and payables into one number: how many days of cash the business has locked up in operations. A cycle that is quietly lengthening year after year is a classic slow-deterioration signal.

None of these is an accusation. A growing company legitimately consumes working capital. The technique is to notice the direction and pace early, then explain it, using the fuller treatment in working capital and the cash conversion cycle.

Check how revenue is recognised

The revenue line is the single most common place for aggressive accounting to hide, because so much of it depends on timing judgements. You do not need to be an auditor to run useful checks here, you need to read the notes.

Ask a few concrete questions. Is revenue recognised when cash or a firm obligation exists, or is a large share sitting in unbilled revenue and contract assets that have not turned into invoices. Did a big chunk of the year’s sales land in the final quarter, which can signal channel stuffing or pull-forward. Are there long-term contracts where revenue is booked on a percentage-of-completion basis, which gives management real discretion over how fast income appears. And does reported revenue reconcile with the cash actually collected from customers over time.

A useful cross-check is to read what management said it would do and compare it against what the numbers show. Guidance and the story told on the earnings call are part of the evidence, which is why learning to read a concall like an analyst and to weigh management guidance matters as much as the arithmetic. When the words and the numbers stop agreeing, that gap is the finding.

Follow the related-party trail

Related-party transactions are dealings between the company and entities connected to its promoters, directors, or subsidiaries. They are legal, disclosed, and often routine. They are also one of the most reliable places for value to leak out of a listed company and into private hands, so forensic work always reads them.

The related-party note in the annual report is your source. The techniques are simple:

• Total up related-party transactions as a share of revenue or profit, and watch whether that share is rising over time.
• Look for loans, advances, guarantees, or investments extended to promoter-linked entities, especially ones that do not obviously serve the listed business.
• Check whether purchases or sales are routed through related entities at terms you cannot verify as market terms.
• Watch for money leaving the listed company toward the promoter group while minority shareholders see little of the cash the business reports.

A single related-party arrangement is normal. A pattern of cash steadily moving toward connected entities, especially alongside weak cash conversion, is a cluster worth taking seriously.

Read the auditor and promoter signals

Some of the strongest forensic signals are not numbers at all. They are the behaviour of the people closest to the accounts.

On the auditor side, read the auditor’s report, not just the financials. A qualified opinion, an emphasis-of-matter paragraph, or a list of key audit matters tells you where the auditor itself was uncomfortable. A sudden auditor resignation or a frequent change of auditors, particularly mid-term, is a signal that deserves an explanation. So do repeated changes of chief financial officer.

On the promoter side, the clearest public signal is share pledging, where promoters borrow against their own holding. A high or rising level of pledged promoter shares is a sign of stress at the promoter level and a source of risk to the share itself, because a forced sale of pledged stock can hit the price regardless of how the business is doing. The mechanics of why this matters are covered in promoter holding and pledging. Alongside it, watch the direction of promoter ownership over several quarters and read the reasons given for any decline.

The practical red-flag checklist

Forensic accounting is a habit, not a one-time audit. Run the same checks on every company, every year, and let the clusters, not any single flag, do the talking.

• Cash versus profit: does operating cash flow track profit over five years, and if not, why.
• Receivables and inventory: are they growing faster than sales, and is the cash conversion cycle quietly lengthening.
• Revenue recognition: how much sits in unbilled or percentage-of-completion revenue, and did the last quarter carry too much of the year.
• Related parties: are transactions with promoter-linked entities large, rising, or routing cash away from minority holders.
• Auditor signals: any qualification, emphasis of matter, resignation, or frequent auditor or CFO change.
• Promoter signals: how much of the promoter holding is pledged, and which way ownership is moving.
• Consistency: do the income statement, balance sheet, and cash flow statement tell the same story once you reconcile them.

The unglamorous truth is that almost all of this is public. It sits in filings anyone can download. The edge is not access, it is the willingness to run the same boring checks carefully and repeatedly, and to treat every red flag as a question to answer rather than a verdict to reach.

Related reading:

• Free cash flow versus net profit: why cash and profit legitimately diverge, and when the gap is a warning.
• Working capital and the cash conversion cycle: how to read receivables, inventory, and payables together.
• Stock forensics: finding problems before the market: the four lenses worked through with real Indian examples.
• Why forensic analysis matters: the mindset behind the checks and the risks they guard against.
• Promoter holding and pledging: why pledged promoter shares are a distinct source of risk.

This article is educational. Altys Labs is not a registered research analyst or investment adviser, and nothing here is investment advice or a recommendation to buy, sell, or hold any security.