Financial Shenanigans Book Review
When it comes to picking the right stock for investment portfolio, analysts and investors rely heavily on the financial statements and reports published by individual companies.
Based on the numbers given in the financial reports and company’s plans and growth estimates about the future, we form our opinions whether the company in question is a good investment or not.
However, there are times where these numbers can be manipulated by the very companies that furnish them in order to paint a rosy picture. It is thus, the duty of every analyst and investor to look for such window dressings and false reporting in order to save himself from being lured into false image and lose his hard earned money.
The Book “Financial Shenanigans:How to Detect Accounting Gimmicks and Frauds” Written by Howard Schilit does just that.
What is the Book all About?
“Financial Shenanigans: How to Detect Accounting Gimmicks and Frauds” Written by Howard Schilit is one of the rare books written on how companies commit accounting frauds by concealing or misrepresenting the number to investors.
The book goes vast lengths, uses real life example to explain how companies falsely boost their revenue by recording sales that have not even taken place or how a business shifts financing cash flows into operating cash flows.
The book hits hard on the changes in accounting principles and how masterful accountants trick analysts with gimmickry.
Types of Financial Shenanigans:
Some of the most common financial shenanigans discussed in the book by the author are as follows:
Earnings Shenanigans:The book gives example of a gamut of earnings shenanigans used by the companies to inflate the revenue by recording the sales even before the real sale has been made.
For example, if a company receives advance payment for the products that is being sold to the client in the future, some companies, in order to show boost in their revenue, record these as if the sales have already been made.
The book also shows how companies use mergers and acquisitions as a tool to manipulate numbers, to show high growth in revenue which, in reality, do not exist.
The author shows how even high quality companies like IBM and Sunbeam use earning shenanigans to boost their revenue by cooking books using fictitious accounting numbers.
Cash Flow Shenanigans: Cash flow is considered to be the most reliable financial statement among all as it is commonly believed that cash flows are hard to manipulate. The simple reason behind it is that if a company generates cash, it will get reflected in a company’s bank accounts. If there anything fishy, the bank details will speak the truth.
However, accounting gurus are much smarter and have a few tricks to boost cash flows if a company is generating very little cash.
This section of the book primarily focuses on how businesses from financing cash flows (money received from sale of bonds or stocks etc) to operating cash flows(money received from cre operations of the business), using loopholes in accounting policies or by concealing the details of real picture of how cash was generated.
This section of the book also discusses in detail how companies use mergers and acquisitions as a tool to make cash flows look stronger than it actually is.
Key metric Shenanigans: This section is especially very useful for investors who attend conference calls or read transcripts.
It examines how top management can deviate an investor’s attention from the real issues such as sales and net profit by referring to non GAAP-measures such as “Same store sales” and “Average Revenue Per User”. It is a must read section for people who do not have much knowledge of accounting reporting standards and how they are used to manipulate the numbers.
What I really like about this book is that it not only uses real life examples as a case study to make their point, but also explain how it was possible to detect these shenanigans before they came out in public.
Learning from Financial Shenanigans:
Reading this book there are few important things I have learned and in my opinion, every investor must also learn as well. These are:
Learn to be Skeptic: Investors always look for stocks that have seen high growth, not realizing that the numbers being presented to them may be fudged.
When something looks too good to be true it most probably is. You will find many companies that are on a fast track of growth, making lots of profit for themselves.
While there is nothing wrong in that, but when a company shows huge growth numbers, it should raise a red flag in the mind of a skeptic if the numbers are really true or there is something fishy about them.
Always verify the numbers of a company specially if they are too good to be true.
Don’t get carried away by the news: Many companies spread positive news about their business in order to get investors interest, making them invest in their stocks.
Companies may use many of the tactics such as announcing huge mergers or acquisition, split or bonus of shares or even high dividends.
Most investors and analysts get carried away by such news as it rapidly pushes the price of a share up for a short span of time.
Aslo this not only helps companies hide their inner weakness, but also help insiders make windfall gains in a short span of time, if they want to exit the stock.
An investor looking to buy quality stocks for long term investment must focus on the quality of the business and if the business is honest in reporting its numbers.
No matter how good a stock may look good on the paper, at the end of the day, it is the crude real numbers that ultimately determine the price of the stock.
Who Should Read This Book?
The final question is, who should read this book? In my opinion there are many who will benefit by reading this book, however there are few types of people who will benefit the most by reading it.
Investors looking to invest in individual stocks: The book is going to be really helpful to those investors looking to invest in individual stocks.
The book gives investors many ways to fact check the authenticity of a company’s reporting, and what is going on in the company quarters to quarters.
If you are someone who invests in individual stocks, this is a must read book for you.
People interested in valuation of stocks: Most investors and analysts use discounted cash flow as a reliable way to value a business. Contrary to popular belief that cash flows cannot be manipulated, financial shenanigans shows how cash flow numbers can be fudged to make it look pretty.
The book is an eye opener for a large community of investors that rely heavily on valuation models and ratios to make their investment decisions.
Someone Who is Interested in financial History:The book takes you through the evolution of corporate scams and accounting frauds.
Being written by American authors the examples shown in the book belong to US based companies like Enron, WorldCom, but you will get the context of it.
The author even goes back in time to show you how investors could have caught onto the false accounting that made these companies the biggest frauds in the history.
Some other Recommended Reads:
“Financial Shenanigans: How to Detect Accounting Gimmicks and Frauds” is a must-have book for all the serious investors. It is easy to read and follow, has ample examples and case studies to present its points, which you can easily use to apply immediately after reading the book.
I would put this book very high on my reading list and would recommend you to read as well