Financial Shenanigans: How to Detect Accounting Gimmicks Fraud in Financial Reports, 3rd Edition

Book breaks financial shenanigans (efforts to deceive investors about a company’s financial health or performance) into three broad categories:

  1. Earnings Manipulations
  2. Cash Flow
  3. Key Metrics
  • Look for profits to grow proportionally to sales

Free Cash Flow

Cash flow from operations minus capital expenditures = Free Cash Flow

Culture of Companies prone to Accounting Shenanigans

  • Lack of checks and balances among senior executives
    • A single dictatorial ruler runs rough shod over the management team e.g. WeWork
    • Executives are related (nepotism)
  • Executives push for winning at all costs
  • Weak and ineffectual board e.g. Theranos
    • Board allows comp plans for operators that create perverse incentives
  • Ineffectual or complicit auditors e.g. Arthur Anderson and Enron
    • Auditors with a long relationship run the risk of becoming complacent or identifying too strongly with the clients incentives
  • Company takes steps to avoid regulator scrutiny, e.g. SPACs

Earnings Manipulation

  1. Recording Revenue Too Soon
  2. Recording Bogus Revenue
  3. Boosting Income Using One-Time or Unsustainable Activities
  4. Shifting Current Expenses to a Later Period
  5. Employing Other Techniques to Hide Expenses or Losses
  6. Shifting Current Income to a Later Period
  7. Shifting Future Expenses to an Earlier Period

Cash Flow

  1. Shifting Financing Cash Inflows to the Operating Section
  2. Shifting Normal Operating Cash Outflows to the Investing Section
  3. Inflating Operating Cash Flow Using Acquisitions or Disposals
  4. Boosting Operating Cash Flow Using Unsustainable Activities

Key Metric

  1. Showcasing Misleading Metrics That Overstate Performance
  2. Distorting Balance Sheet Metrics to Avoid Showing Deterioration”

Links to this note