New York/ July 22, 2017
Howard Schilit is the forensic doctor who gets called for a second opinion by the biggest investors around. Any stimulus that causes anxiety to institutional investors is good for him. His firm Schilit Forensics works with around 50 investment firms and tells them which companies are the ones playing games. He founded subscription-driven Centre for Financial Research and Analysis which proactively published who the bad actors were. After selling it off, he had a non-compete for seven years post which he started Schilit Forensics, which is much quieter about what it does given that company managements have also wizened up over the years. As Schilit told us during the interview, the intent behind the first edition of Financial Shenanigans in 1993 was to have a one-stop guide where investors could read about the different tricks and techniques used in window-dressing. The 90s though seem like a bygone era and now in addition to earning shenanigans, companies are resorting to cash flow shenanigans. They are tweaking key metrics which appeal to the investing community. But the Sherlock Holmes of accounting won’t let them have it easy. Schilit is back with a revised fourth edition to keep in step with the spring-loaders.
Let us start with your seven financial shenanigans. Can you illustrate each of those with examples? Which are the most dangerous according to you?
In the early days of doing research on the subject, in the 1990s, we identified seven categories of how companies can manipulate their earnings. The seven break down into two major sub groups. The first five of those seven deal with how the goal of the company is to make it look more profitable. This is intuitive. If you play games and risk going to jail, why would you do that to make the company look less profitable? But that is the second category — where the company cheats to look less profitable, which we will come to later.
The first two of those seven involve making the firm’s topline/sales or turnover, as you call it, look stronger than it really is. Shenanigan number one is to record the revenue too soon. So, if the transaction really should have been in the third quarter of 2017, but has been pushed to the second quarter of 2017 by the company, that is more or less what this category is about