I knew the second that I started reading Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud in Financial Statements that I would love it. The book by Howard Schilit and Jeremy Perler dives deep into the dark world of corporate accounting, blowing apart common tricks corporate accountants use to make businesses look better than they are.
The book hits hard on the many changes in GAAP accounting and how masterful accountants trick business analysts with gimmickry. In total there are:
- 7 Earnings manipulation shenanigans – These run the gamut from simple revenue recognition discrepancies to very disingenuous sales processes that allow a company to record revenue before a sale is even made. The author boosts this section of the book with high-quality examples from leading public companies including Sunbeam and IBM. You won’t believe the extent to which high-profile companies report earnings beats with fictitious accounting numbers.
- 4 Cash flow shenanigans – The cash flow statement is one of the most difficult to engineer – a company produces cash, or it doesn’t. However, accounting teams still have four methods to boost cash flows when a business would otherwise produce very little free cash. This section primarily focuses on how businesses shift financing cash flows (money from stock and bond sales) into operating income. Also, this section uncovers how acquisitions and disposition can be used to make cash flow look stronger than it really is.
- 3 Key metric shenanigans – This section targets the key metrics used by executives when they talk about their business and brand. In particular, it examines how corporate brass can turn attention away from struggling businesses with non-GAAP measures like “same store sales” or “average revenue per user.” This section curiously touches on the subject of “bookings,” a metric used by recent IPOs like Groupon to hide their true revenue per user metrics. This is a must-read section for people who tune into corporate conference calls or who read conference call presentations.
Learn to Become a Skeptic
The best part about a book like Financial Shenanigans is that it will teach any investor to become a true skeptic – a real analyst. Before reading the book, I felt as though I had a very firm grasp on basic accounting principles. However, after reading from cover to cover, I realized how very few of these shenanigans I could actually catch.
Most importantly, I think this book will also help anyone who:
- Invests in individual stocks – Particularly in large cap companies, where the sheer complexity of one or many businesses can hide the true operating performance of a company, this book gives investors a way to “fact” check the going-ons of a company from quarter to quarter. If you invest in individual stocks, this is a must-read book.
- Values stocks on cash flows – The cash flow shenanigans are absolutely incredible. Anyone who uses a discounted cash flow analysis to value companies will appreciate the wisdom in Financial Shenanigans. The cash flow statement is not as impenetrable as investors seem to believe.
- Wants to learn more about financial history – The book takes you through the evolution of corporate scams and accounting frauds. The author makes frequent references to massive scams like Enron and Worldcom, and 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 Wall Street history.
What I like most about the book is that it doesn’t just expose the gimmicks that businesses use to fake their financials. Instead, the authors go to great lengths to give examples, and then explain how you can fact check the accounting of any public company.
All in all, at little more than $18 for the hardcover, this is a must-own book for any serious individual stock investor. It’s easy to read, easy to follow (there are literally hundreds of examples), and easy to apply what you learn to companies you watch immediately after reading.
I would definitely put this book high on my investing reading list – perhaps second after Ben Graham’s famous Security Analysis. It really is that good – and that informative.
Editor’s comment: It sounds like a great book to read about forensic accounting. I’m definitely going to add it to my list.