Flash Technologies, Inc.

: Risk Analysis and

Resolution of Client Issues

Risk Analysis
Flash Technologies, Inc., a company that designs, manufactures and markets an
extensive line of PC cards, is showing a rapidly growing and currently they engaged our
firm to perform the annual audit because they determined that their previous auditors
could no longer provide the necessary support due to its increased international
investments. Thus we are hereby to make a thorough analysis of the business risks of
the company.

As we will see, the company faces several risks. Some of this risks are related to its
characteristics others to the external environment. We will describe those risks around
categories such as: General Areas of Risk and Specific Financial Statement Risks.
Within these categories we will focus on factors that will influence acceptable audit risk
and inherent risk.

General Areas of Risk

The company is rapidly growing, nevertheless they face several risks. These risks are
influenced by factors like the size of the company, ownership, liquidity position, among
others (acceptable audit risk) or by factors like the results of previous audits,
transactions between related parties, and even unusual transactions (inherent risk). We
list the following:

• Public high tech company – this type of companies have more users, thus their
activity is constantly being watched, depending on audit companies to indicate
the reliability of their financial statements. The more users depend on such
information the less is the acceptable audit risk.
• Allegations of the lack of integrity of Mr. Schwimez – it represents a risk
because it not only gives a bad image of the company, mining future
negotiations, but it also represents a risk for the auditor because if allegations
are true the auditors reputation may also suffer. In this cases we have to decide
whether to engage or not, and if we engage we will have to reduce the
acceptable audit risk.
• Transactions between future related parties (CCB Computers) and the sales of
“Flash 2005” to one company – this will be an inherent risk because it might
 Flash Technologies, Inc.: Risk Analysis and
Resolution of Client Issues
occur material misstatements due to the lack of establishment of the fair value of
the product price.
• SEC Investigation – this may also represent a risk because if something wrong is
found, we will face some consequences due to our previous engagement. We
will be held responsible for any fraud encountered and the company may have to
close down.
• Industry – we consider this a risk due to the fact that the company, being a small
player in the industry, faces quick technological changes, industry standards, and
intense competition. Technology sector is a growing market and is one of the
most risky, being constantly investigated due to their fast growing.
• The agreement to form “Flash Korea” and other acquisitions – the agreement
represents a risk because there is no assurance that operations will start on time
and also the company may not be well prepared to face such challenge since it is
still a small company. Purchasing DCI also represents a risk due in great part to
successively income losses. It may also represent a risk for us because the
transactions may not be well recorded.
• Source of supply – the company has experienced shortages in electronic
components used for production. This may result from the fact that the company
does not maintain long term supply agreements and also these agreements are
maintained with sole or single-source vendors. This can have a negative impact
on the company’s financial statements due to delays or reduction of product
shipments.
• Reliance on only one product – this factor represents a risk because the company
relies only upon the success of this one product (98% of the sales), but if an
alternative and better product appears the company will not have any product to
sustain it.

Having seen the risks, we may conclude that an audit to this company may involve a big
team because it is operating in a highly growing market, where change occurs at a very
quick pace. The company also faces the SEC investigation and the CEO is somewhat
not a trustful person. Some allegations against him may lead us to reduce the acceptable
audit risk. We will now identify some financial statement risks.

Specific Financial Statement Risks

 Flash Technologies, Inc.: Risk Analysis and
Resolution of Client Issues
In this case we will analyze the potential risks associated with the company’s financial
statements. In this kind of risks, we have to assess of the likelihood of any material
misstatement. If any misstatements urge, we will have a high inherent risk. Mainly these
risks are associated with the rapid unexplained growth. They are the following:

• The unexplained increase in assets – this is a risk because we have no way to

explain this sudden growing. Even if the company is having great success the
date showed is not consistent with the industry ratios (Exhibit 1).
• Increase in sales – this also represents a risk because it may raise some issues
related to the reasonability of the procedure. Also it does not keep up with the
pace of the industry.
• Research and development costs- these costs have do not correspond to the
increasing in sales which may be a risk because it shows that something might
be wrong.
• Large negative outflow from operations activities – this shows us that the
company might be facing some serious economic issues, since great part of the
operations are being fund by financing activities. If the company fails to pay to
all its creditors, it will face a going concern issue since it has no capacity to fund
operations activities through other means.
• Inventory Turnover – this also represents a risk since the company’s turnover
ratio is 1.3 compared to the industry’s 8.1. This may raise issues related to the
company’s ability to sell the product and to perform on the market.
 Flash Technologies, Inc.: Risk Analysis and
Resolution of Client Issues

Flash Technologies, Inc Industry

2005 2005

Current Ratio 5.28 1.50

Quick Ratio 3.28 1.10

Debt to Equity Ratio 19.8% 29.0%

Inventory Turnover 1.3 8.1

Profit Margin 12.9% 14.60%

Return on Total Assets 8.78% 5.03%

Ratios (Exhibit 1)
Flash Technologies, Inc.: Risk Analysis and
Resolution of Client Issues