Round-tripping is the most technically sophisticated form of financial manipulation in lending relationships. It is also the most difficult to detect through standard audit or monitoring procedures, because every document supports the recorded transactions. The purchase orders exist. The invoices exist. The goods receipt notes exist. The payments were processed through normal banking channels. The revenue was received through normal banking channels. The P&L reflects both the cost and the revenue. The bank statements show operating activity.
The economic substance is zero. No goods moved. No services were delivered. No value was created. The borrower paid itself through intermediaries, recording both expense and revenue to inflate the financial statements on which the lender relies.
The basic mechanism
Company A pays Rs 1 crore to Vendor B for “consulting services.” Vendor B retains Rs 5 lakh (its fee for participating in the arrangement) and transfers Rs 95 lakh to Entity C. Entity C retains Rs 5 lakh and transfers Rs 90 lakh to Customer D. Customer D invoices Rs 90 lakh to Company A as “technology services” and pays Company A Rs 90 lakh.
Company A’s P&L shows: Rs 90 lakh of revenue (from Customer D) and Rs 1 crore of cost (to Vendor B). Net effect: Rs 10 lakh apparent loss. But the revenue is fictitious: it inflates the top line, which inflates the EBITDA, which inflates the DSCR, which supports the facility size. The Rs 10 lakh “loss” is the cost of the inflation: the aggregate facilitation fees retained by the intermediaries.
The financial statements show a company with Rs 90 lakh more revenue than it actually earned. The DSCR is higher than it should be. The facility is larger than the real economics support. The lender is exposed to the gap.
Variants
Channel-stuffing round-trip. Company A ships Rs 5 crore of product to Distributor B near quarter-end. Revenue is recognised at shipment. Distributor B has not placed a firm order and has a right of return. Distributor B’s inventory is financed by a credit facility arranged by Company A. The product sits unsold. In the next quarter, Rs 3 crore is returned. Q4 showed Rs 5 crore of revenue. Q1 shows Rs 3 crore of returns. The annual report presents the return as a “seasonal adjustment” or “quality-related return.” The net revenue is Rs 2 crore, but the timing of recognition inflated Q4 (possibly the quarter the covenant was tested or the annual financials were prepared).
Pre-payment round-trip. Company A advances Rs 2 crore to Vendor C as a “procurement advance.” The advance sits on the balance sheet as an asset. Vendor C does not supply goods. Instead, Vendor C routes Rs 1.8 crore through Entity D, which invoices Company A as a “customer” for Rs 1.8 crore. Company A records Rs 1.8 crore of revenue. The advance (Rs 2 crore) remains on the balance sheet. The revenue (Rs 1.8 crore) appears in the P&L. Neither represents genuine economic activity. The advance is a permanent extraction dressed as a temporary receivable, and the revenue is the return leg of the same money.
Detection methodology
Step 1: Correlated cash flow analysis. The detection starts with data, not suspicion. Every outward payment above the threshold is matched against every inward receipt within a 7 to 21 day window. Pairs that match in timing (payment on Day 1, receipt on Day 8) and proportion (payment of Rs 1 crore, receipt of Rs 85 lakh to Rs 1 crore) are flagged for counterparty mapping.
The matching is automated: the full bank statement population (every debit and every credit across all accounts for the review period) is subjected to the correlation algorithm. The algorithm does not require a hypothesis. It identifies pairs that exhibit the timing and proportionality characteristics of circular flows.
Step 2: Counterparty network mapping. For every flagged pair (payment to Vendor X, receipt from Customer Y), the test determines whether X and Y are connected: common directors (current or historical), common shareholders (including through layered entities), common addresses, common bank signatories, common phone numbers, common email domains, or connection through an intermediary entity that links both.
If X and Y are independent, the correlation may be coincidental (the borrower paid a vendor and received revenue from a customer in the same week, which happens routinely in a healthy business). If X and Y are connected, the correlation warrants tracing.
Step 3: Cash tracing through the circuit. For flagged pairs where the counterparties are connected, the money is traced through the intermediaries. If the cash completes a circuit (borrower → vendor → intermediary → customer → borrower), the transactions are circular. The circuit may involve two entities (simple) or six entities (complex). The complexity of the circuit is directly proportional to the sophistication of the arrangement.
Step 4: Economic substance verification. For each confirmed circuit, the test verifies: did the goods or services exist? Were they delivered? Were they consumed or resold? Is there physical evidence (inventory movements in the ERP, production data, logistics records, consumption records, customer delivery confirmations) corroborating the transactions?
A circuit without physical corroboration is a round-trip. The transactions occurred on paper and in the bank accounts. They did not occur in the physical operations of the business.
Step 5: Restatement. Total revenue, cost and profit attributable to circular transactions are quantified. The financial statements are restated excluding the round-tripped amounts. The gap between reported and restated revenue, margin and DSCR is the inflation. On a facility sized against the reported performance, the inflation is the excess exposure: the amount of lending that the real economics do not support.
Northrop applies this test in forensic audit mandates under bank directives. Business@NorthropIndia.com | +91 92899 25657