Let’s make it clear right away — this series isn’t about tips to make money in the stock market. Instead, it will help you spot companies that manipulate their accounts to show inflated profits or engage in questionable practices.
The aim of this monthly series is to help you understand a business, read a stock correctly, and recognise companies best avoided. Everyone wants to earn from the market, but few spend time learning how it really works.
All About Auditors
We begin the first part of this series by looking at one important question: how should investors read what auditors say? We will focus on a small but crucial area — a company’s inventory.
Before going ahead, think about this: what separates institutional investors from retail ones?
The main difference is that institutional investors take annual reports seriously.
In India, annual reports are long and complex, so most retail investors skip them. But there are parts written in simple language that anyone can understand. Of course, some technical sections are difficult even for experts — one of them being the auditor’s statement.
Why does this matter? Because even a small comment or observation from an auditor — often hidden in fine print — can reveal a lot about a company’s quality, internal systems, and transparency.
This series will help you learn how to read annual reports, especially to notice what auditors are saying about the companies you invest in. After completing their review, auditors (some more thorough than others) issue a short report giving their opinion on the company’s financial statements.
Kinds of Auditor Opinions
If the auditor finds enough evidence and the accounts follow all rules, they issue an unmodified (clean) opinion, which means the financial statements present a fair and accurate picture of the company.
If there’s a problem limited to one area — but not serious enough to affect the entire report — they issue a qualified opinion and explain the issue.
If major and widespread problems are found, the auditor gives an adverse opinion, meaning the financial statements cannot be trusted.
And if the auditor doesn’t have enough information to form an opinion — due to restrictions or uncertainty — they issue a disclaimer of opinion, stating why no conclusion was possible.
In this first part, we’ll focus on inventory — how it can be manipulated, what auditors look for, and which phrases in reports signal problems.
How Auditors View Inventory
Imagine your company runs a chain of grocery stores across the country. Shelves look full, records show large inventory, and profits appear strong. Then the auditor arrives — their job isn’t to admire neatly arranged cartons but to check if the numbers are real.
They focus on four key questions — four lenses that help them test accuracy. Each lens has its own tricks that companies use to manipulate figures, and standard checks auditors use to catch them.
Quantity & Ownership
Auditors first check whether the stock physically exists and whether the company truly owns it.
How they check: They attend stock counts, match records to actual items, open boxes, weigh materials, and verify documents, especially for goods stored with third parties or in transit.
Common manipulations: Fake stock entries, counting the same items twice, or claiming ownership of stock held elsewhere.
Warning signs: Watch for phrases like unable to obtain sufficient appropriate evidence regarding rights over inventory held at third-party locations. This often signals weak control or even manipulation — common among smaller retail and FMCG companies.
Value & Realisability
The third lens focuses on valuation. Inventory should be recorded at the lower of cost or market value.
How they check: Auditors test selling prices, review aged stock, assess markdowns and write-offs, and analyse manufacturing costs and yields.
Common manipulations: Not recording losses when market prices fall, overstating costs, or adding extra overheads to inflate profits.
Warning signs: Look for lines such as inventory has been carried at cost which exceeds its net realisable value. This means profits are overstated, and the auditor is flagging it clearly.
Cut-off & Movement
The last lens checks whether inventory movements are recorded in the right financial year.
How they check: Auditors verify purchase and sales records near the financial year-end, match delivery dates, and review ledger entries for last-minute adjustments.
Common manipulations: Fake March-end sales, early booking of goods received, reversal of credit notes, or fake transfers.
Warning signs: Key Audit Matters mentioning cut-off controls were not operating effectively. Also, when banks are involved, auditors must check if quarterly stock statements match company books — another place where manipulation is often caught.
The Takeaway
Inventory figures can reveal whether a company is honest or not. When auditors raise doubts — about existence, ownership, value, or timing — investors should pay attention.
Learning to read these signals can protect you from investing in weak or dishonest businesses.
(The writer has a keen interest in business and the dynamics of stock markets)
