Finance
by Howard Schilit
How do companies fake a good year?
Howard Schilit, a former accounting professor, founded a research firm, CFRA, to catch companies bending their numbers. Financial Shenanigans is his field guide. It sorts the tricks into families and lists the warning signs, so investors can spot trouble before the share price does.
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Many earnings shenanigans move revenue or costs into the wrong period. Schilit's families include recording revenue too soon, shifting current expenses to a later period, and dragging future expenses into today with a big one-time charge. Over time the totals may even out, but each year's picture is false.
Investors learned to trust cash flow over profit, so companies learned to game it. Schilit shows how operating cash flow gets inflated by moving normal costs into the investing section, or by counting money that's really borrowed as cash from operations. Check where each big cash item sits.
Companies also report their own measures, like adjusted profit or subscriber numbers, which follow no accounting rules. Schilit's key metrics shenanigans include defining these to flatter the business, then quietly changing the definition when the trend turns bad.
Schilit's red flags are often simple comparisons. Money owed by customers growing faster than sales. Stock piling up faster than sales. Operating cash flow falling behind reported profit. Each can have an innocent explanation, so treat it as a reason to ask questions.
Early revenue
A common trick is booking sales before the customer has really taken the goods or agreed to pay.
One-off gains
Profit from selling a factory once is worth far less than profit from the everyday business.
Hidden costs
A firm can make this year look better by pushing today's costs into later years.
Cash flow
Cash flow can be dressed up too, for example by counting borrowed money as cash from the business.
Pet metrics
Be wary when a company invents its own measures of success and keeps changing them.
A story from the book
WorldCom paid other telephone companies to carry its calls, an ordinary running cost. From 2001 it recorded billions of these line costs as capital assets instead. Profit looked healthy, and because capital spending sits outside operating cash flow, cash flow looked healthier too. It went bankrupt in 2002.
One thing to try
Take a company you hold shares in, or your employer if it publishes accounts. Compare last year's growth in sales with the growth in money owed by customers. If what customers owe grew much faster, read the notes to find out why. It's a classic Schilit warning sign.
Knotd has the key ideas from 250+ non-fiction books, each in a few minutes, in plain words. Financial Shenanigans comes with a Spot the Trap case to make it stick.
Get the whole book on KnotdOpen in the appHow do companies fake a good year? Howard Schilit, a former accounting professor, founded a research firm, CFRA, to catch companies bending their numbers. Financial Shenanigans is his field guide. It sorts the tricks into families and lists the warning signs, so investors can spot trouble before the share price does.
Moving profit between years; Cash flow can be dressed up; Home-made metrics; The warning signs.
Take a company you hold shares in, or your employer if it publishes accounts. Compare last year's growth in sales with the growth in money owed by customers. If what customers owe grew much faster, read the notes to find out why. It's a classic Schilit warning sign.
Yes. Knotd has the key ideas from Financial Shenanigans in a few minutes, in plain words, plus a Spot the Trap case to test them. It's one of 250+ non-fiction books in the app.
