Memorandum on Analyzing a Potential Client: Key Points to Consider

Introduction and Recommendation

1. The memorandum should present an introduction which includes your recommendation and a preview of what you did to come up with you recommendation.

2. Following the introduction should be a brief (one paragraph) company profile that comments on, among other items, the history of the firm, its major products, and operating environment (e.g., industry, geographic locations, etc.).

3. The report should include an analysis of key items:

a. Management integrity – look at the executives, board of directors, and other key players in the company and see if there are any indications of issues with integrity (e.g., lawsuits against them, fraud possibility, SEC actions). News articles will be helpful to inform this portion of the report.

b. Ratio analysis – you will need to discuss the apparent financial condition of the firm and highlight key financial ratios, such as, the current ratio, return on assets, inventory turnover, etc.  In particular, you should bring to the partner's attention the ratios and trends that may be indicative of the future prospects of the firm (good or bad).  For instance, if the return on sales percentage has plummeted in recent years, that fact should probably be brought to the attention of the partner (and, of course, you should provide some explanation as to why this sharp downturn has occurred).  Both cross-sectional and longitudinal analyses will be appropriate. Additionally, tabular summaries and exhibits (graphs, pie charts, time-series charts, etc.) will be useful means to present quantitative data regarding the firm. Feel free to use all reference sources available in the library or online, such as, Disclosure, Dun & Bradstreet, Moody's, Robert Morris & Associates, Standard & Poor’s, Value Line, WSJ Index, etc., in preparing your memorandum. Many students have indicated that IBISWorld is a good source for industry analysis. Online sources that supply comparative industry data will be particularly helpful.

c. The presences of risky accounts – Look at the financial statements and see if the company has large sums in risky accounts (e.g., large amounts in financial derivatives).

d. Internal Controls – Review management’s assessment of internal controls over the past couple of years. Are there any issues with internal controls? Are there any indications that internal controls might be an issue? Is there any information about internal control weaknesses in their prior audit reports?

e. Complex/Unique Transactions – are there any complex or unique transactions which might cause an issue in the audit? Review the annual report, including the financial statements and the risk disclosures of the firm and of other firms in the industry. Does anything stand out as being particularity difficult? If critical audit matters are disclosed, what are the nature of those matters?

f. Litigation Risk – review the litigations for the client. Are there any shareholder actions? Are there any substantial institutional holders?

g. International Issues – is there a substantial presence internationally, especially in countries susceptible to FCPA violations? Are there likely to be issues with cultural differences in the business environment relative to the US?

4. Finally, you should conclude your memo with a recommendation for the partner as to whether you should accept the firm as a client or not. You must make a decision; you cannot make your decision conditional, unless there is a specific future (e.g., a pending merger) on which the contingency rests.

In addition to the items given above, feel free to comment on other factors relevant to the acceptance of a client. For a discussion of other factors to consider when evaluating a potential client, refer to any undergraduate auditing text.