Red Deserts Official Financial Information and Their Actual Activities - Essay Example

We have noted that based on the official figures the profit rates are within the industry but if adjusted per audit, rates are below industry averages. This is aggravated by the fact that there is also a shortage in cash of about $7 million based on the audited cash flow statement. A deeper analysis would indicate that the purpose was to cover the cash shortage, which may represent the misappropriation of company funds.

Based on the auditor’s report, it appears that management is creating fake sales and fake purchases of equipment. The fake sales necessitated overstatement of inventory and understatement of cost of goods. However, the overstatement of inventory is reclassified as fake purchase equipment. These activities resulted in overstated sales, overstated income, understated cost of sales, overstated gross margin, and overstated equipment. Overstatement of equipment might have been intended to defer the recognition of expenses through future depreciation expenses. The volatility of accounts receivable and accounts payable compared to creditors was caused by fake accounts payable and accounts receivable at the same time for Red Desert. Faking the same is a way of manipulating cash.


Questionable Business Dealings with investors

Red Desert’s high liquidity did not come from the operation but the investment of stockholders. A $10 million fresh infusion of equity in 2001 just went to wastage 2001 because management can hide the shortage of $ of 7 million in cash. This would be fooling investors. If Red Desert has fooled the new investors in 2001, what is the assurance that they will not fool Surftex when the latter would have a strategic alliance with it?

It is really hard to deal with dishonest management. However, when we consider the financial stability and liquidity of Red Desert as bases for having an alliance, it would appear that the debt-to-equity ratio and current ratio of Red Desert are still good. In terms of profitability, it is not too bad not to give it a chance. With the willing investors coming in 2001, it would show that there is a good prospect in its business. Therefore, it is recommended that unless Surftex would be given a controlling interest when the strategic alliance is pursued, there is no reason to have an alliance with Red Desert. Read More