The Role of Funds Tracing in Forensic Accounting

Summary: Companies that lack internal accounting controls may be giving money to the wrong individuals or entities without even knowing it. Funds tracing is a critical component of forensic accounting that shows where your cash is going and who is receiving it. Learn about the basics of funds tracing and how it is used to safeguard the financial health of your business.

In the early days of establishing a business, it is often easier to keep track of how every penny is spent. But as a company grows in both size and scope, expenditures will increase and become more varied, as will the number of individuals with access to company funds and sensitive financial information.

Without efficient oversight and the proper accounting controls in place, it may become increasingly difficult to determine where the money is going and why, which can lead to significant financial losses over time. In cases where discrepancies are uncovered or unlawful activity is suspected, a technique called funds tracing can be used to “follow the money” and determine whether or not it is being distributed properly.

What is Funds Tracing?

Funds tracing, also referred to as financial tracing or cash tracing, is a forensic accounting technique that involves analyzing the flow of funds to identify and reclaim assets that may have been hidden, misappropriated, or, in some cases, distributed accidentally.

Funds tracing is typically conducted as part of a larger financial investigation and often plays a critical role in supporting legal proceedings. Though commonly seen in commercial litigation, funds tracing may also be utilized in civil cases. During a divorce settlement, for example, it can be used to identify assets and ensure a fair distribution between parties.

Who Performs Funds Tracing?

When it comes to safeguarding the financial health of your business, having the right team in place is the first step toward a successful outcome. An professional experienced in forensic accounting will have the knowledge and additional training necessary to conduct a funds tracing analysis, using various tracing methodologies to support their investigation.

Forensic accountants are CPAs who use their accounting, auditing, and research skills to meticulously analyze financial data and look for any evidence of negligence or misconduct. Unlike auditors, who generally perform planned audits on a set schedule, forensic accountants are employed when there is a specific problem or issue that requires additional insight.

How is Funds Tracing Done?

Gathering and analyzing large quantities of financial data is a complex undertaking. Typically, the process of funds tracing happens in three stages. The first is data collection, the second comprises review and analysis, and the last stage focuses on asset recovery.

1. Data Collection

Funds tracing begins with gathering and organizing all of the necessary financial data relevant to the investigation. The forensic accounting team will compile information from both public records and internal sources, including financial statements, banking and transaction histories, investment records, tax filings, and real estate records. They may also ask for the names of employees and other stakeholders with access to company finances and request interviews with those individuals as necessary to create a more complete picture.

2. Review and Analysis

Once all of the relevant information has been collected, investigators will look for patterns and connect the dots to piece together a timeline of financial activity. Various tracing methodologies may be used at this stage to help unravel commingled funds and determine whether or not the money was allocated correctly (and legally). These include FIFO (first in, first out), LIFO (last in, first out), and LIBR (lowest intermediate balance rule). Using specialized tools and software, forensic accountants will pinpoint irregularities during this step and are often able to uncover hidden assets.

3. Asset Recovery

In cases that involve funds tracing, the end goal is always recovery. At this stage, forensic accountants provide a detailed report of their findings and may work with attorneys as well as law enforcement officials to ensure any and all financial assets that have been misappropriated are quantified and recovered. They may also be asked to provide expert witness testimony in court.

When is Funds Tracing Necessary?

While most people associate funds tracing with large-scale fraud and embezzlement cases, there are many situations in which creating a money trail can be beneficial for businesses.

For example, funds tracing may be used during the due diligence process in preparation for M&A transactions to gain insight into a company’s financial performance and reveal any potential red flags that may prevent a smooth transition. Likewise, funds tracing is often used in bankruptcy cases to ensure all assets have been disclosed.

Forensic accountants with experience in tracing assets and analyzing the flow of funds can also provide peace of mind for businesses concerned about inefficient accounting controls. In many cases where a company has grown too large and oversight is lacking; funds may end up in the wrong hands—such as a Vendor A receiving a payment that was actually meant for Vendor B. Over time, seemingly small errors like this one add up and can amount to a considerable impact on the financial well-being of the business.

Reasons to Implement Funds Tracing

Funds tracing is an invaluable tool for businesses looking to strengthen their financial security and make strategic decisions. While the need for it may not always be clear, the following scenarios are among the most common reasons to implement funds tracing.

• Fraud investigations (including embezzlement and money laundering)
• Due diligence prior to mergers, acquisitions, investments, and partnerships
• Bankruptcy and insolvency cases, to maximize debt recovery
• Gain a better understanding of cash flow to support business optimization
• Updating internal accounting controls to avoid mismanagement of funds

Final Thoughts: See Where Your Money Has Been, and Where It’s Going

Aprio is a business advisory, tax, and accounting firm serving the industries shaping the global economy. Our Forensic Services team combines time-tested experience with deep industry knowledge to safeguard the financial health of your business and navigate litigation challenges. Utilizing the most current funds tracing tools and technology, we help you understand exactly where your cash is going and who is receiving it.

Our advisors also provide tailored guidance on implementing proper accounting control policies and procedures to improve oversight, eliminate errors, and prevent financial wrongdoing. Schedule a consultation with our Forensic Services team to learn more.