The Safal Niveshak Mastermind Module 3 | Lesson 29

Financial Shenanigans – Part I

Module 3 | Lesson 29

“What has been will be again, what has been done will be done again;
There is nothing new under the sun.”
~ Ecclesiastes

Thus begins the preface of the landmark book Financial Shenanigans, written by
Howard M. Schilit, whom I had quoted at the start of Lesson 22 where we began the
section on financial statement analysis.

I had also mentioned then how the issuers of financial statements – the for-profit
companies – have their primary objective as maximizing shareholders’ wealth, and
not educating them about their financial condition. Now how can a company
maximize shareholders’ wealth? One way is by reducing its cost of capital.

Simply stated, the lower the interest rate at which a company can borrow or the
higher the price at which it can sell stock to new investors, the greater is the wealth of
its shareholders.

From this standpoint, the best kind of financial statement is not one that
represents the company’s condition most fully and most fairly, but
rather one that produces the highest possible credit rating and price-
earnings multiple.

Don’t get me wrong here. All companies and their managements are not there to
scam you with incorrect financial information. In fact, while most companies act
ethically and follow prescribed accounting rules when reporting their financial
performance, some take advantage of gray areas in the rules (or worse, ignore the
rules altogether) in order to portray their financial results in a misleadingly positive
way.

Management’s desire to put a positive spin on financial results has been around as
long as corporations and investors themselves. Dishonest companies have long used
these tricks to prey on unsuspecting investors, and it is unlikely that they will ever
cease to do so.

As King Solomon observed in the book of Ecclesiastes, “What has been will be again,
what has been done will be done again.”

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With the never-ending need to please investors, the temptation for management to
exaggerate the positive through the use of “financial shenanigans” will always exist.
The lure of accounting gimmickry is particularly strong at companies that are
struggling to keep up with their investors’ expectations or their competitors’
performance.

And while investors have become more savvy to these gimmicks over the years,
dishonest companies continue to find new tricks (and recycle old favourites) to fool
investors. Amidst this, it has become ever more important for you, as an investor, to
be very careful while reading a company’s financial statements. In fact, there is no
way you can invest your hard earned money in a business whose financial condition
you don’t understand.

Now, understanding how to read financial statements is important to identify good

companies from bad – as we have understood over the past few lessons. But that’s
not enough. You must also know how to identify the gimmickry some companies use
to portray good financial position – through the use of…

Financial Shenanigans
As per Investopedia, financial shenanigans are…

…acts or actions designed to mask or misrepresent the true financial performance

or actual financial position of a company or entity.

Financial shenanigans can range from relatively minor infractions involving

creative interpretation of accounting rules to outright fraud over many years. In
almost every instance, the revelation that a company’s stellar financial
performance has been due to financial shenanigans rather than management
prowess will have a calamitous effect on its stock price and future prospects.

Depending on the scale and scope of the shenanigans, the repercussions can range
from a steep sell-off in the stock to the company’s bankruptcy and dissolution.

Satyam is one example of blatant

indulgence in financial shenanigans,
which all of us remember very well.

While it is not the only Indian company

to have taken its stakeholders for a ride
(while the CEO was riding the tiger!), it
is an unforgettable case simply because
not many people expected this from a
company that…

• Was India’s 4th largest IT services player, and thus a torchbearer for things
that were right with this country
• Employed 50,000+ employees – a too-big-to-fail types
• Earned annual revenue of US$ 2+ billion
• Won an award for being among the best in the world for corporate governance
(and just 2 months before the scam broke out)

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• Had one of the “Big Four” audit firms – PwC – as an auditor

So, while Satyam was winning accolades in India and worldwide for its business and
so-called corporate governance, its CEO Ramalinga Raju was busy creating Rs 7,000
crore worth of fake bills to siphon cash out of the company. What is worse, the
auditors and independent directors did not come to know about it, or so they
claimed!

Ironically, one of the company’s long-standing independent directors, Professor

Krishna Palepu of Harvard University, was considered a leading authority on
corporate governance. Among the executive education programs he taught was Audit
Committees in a New Era of Governance! He also co-led Harvard’s Corporate
Governance, Leadership, and Values initiative, launched in response to the wave of
corporate scandals and governance failures.

Professor Palepu seemed to have had a lapse in good governance judgment. While
serving on Satyam’s board, he also accepted “special remuneration” of nearly US$
200,000 in 2007 for providing professional services.

While I am not questioning either the quality of the professor’s services or the
fairness of the amount of remuneration received, it is hard to see how Palepu can be
considered “independent”.

Anyways, coming to Satyam’s financial accounts, the huge cash that the company’s
annual reports stated did not exist in reality!

In January 2009, Raju admitted to inflating cash and bank balances by Rs 5,040
crore, overstating debtors’ position of Rs 2,650 crore as against the actual figure of
Rs 490 crore and non-disclosure or understatement of liabilities worth Rs 1,230
crore.

Now scams like Satyam – and others that erupt at regular frequency in India and
around the world – lead one to ask two simple questions

1. How does this keep happening?

2. How can a small investor see red flags when experts have often failed to do so?

Let me take up the first question first.

It Starts Small
Typically, a CEO does not wakes up one morning and says, “I feel like adding 5,000
crore rupees to our revenue today.”

He, alongwith his trusted cohorts (often they also include auditors), usually start by
fudging the number a little–and then it grows.

It is usually a response to competitive pressures. Companies have targets that they

need to reach every month, quarter and year. These targets can come from their
internal budgets or from the expectations of their shareholders and stock market
analysts.

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The fiddle is easy to rationalize at first. Managers typically have confidence in their
skills and believe that their company is fundamentally sound. Given that, it’s easy to
rationalize that while we’re just a little short on the numbers now, we will make it up
in the future, and nobody will know.

It gets out of control. When the company is unable to make up the gap, a larger
distortion is needed to cover it up. This in turn creates pressure to deliver even better
results – which leads to bigger cover-ups, and so on. This is exactly what Satyam’s
Raju indicated of in his letter disclosing the fraud…

Now, when an accounting fraud – like Satyam – involves reporting cash that is not
there, it is typically the result of adding fraudulent transactions, such as cash sales, to
customers that never happened. These types of transactions should have been
audited to assure their legitimacy.

In the case of Satyam, the auditors signed off on the financial reports, raising
concerns that even the increased auditing standards imposed may not be sufficient.

Amidst this, we as investors can only hope for improvements in governance, audit
and legal penalties, as that would disincentivise managers from committing such
frauds.

Identifying Shenanigans
Let me now bring you to the second question I asked above – How can a small
investor see red flags when experts have often failed to do so?

You see, it’s not about being a small investor or a large investor / expert analyst /
fund manager to be able to spot financial misdoings a company may be committing.

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You need to have a checklist of things that can go wrong and the integrity to go
through that checklist before you commit your funds to any business, however good
or honest it may seem.

You must have a checklist of key financial shenanigans that companies indulge in, so
that you can identify a red flag when it appears while you are going through a
company’s annual reports and financial statements.

Now what are the kinds of shenanigans you must keep an eye on?

Well, some are very explicit and would appear even if you read an annual report
while watching a football match. Like this one from a Kolkata-based steel company,
Vikash Metal and Power, which reported a “unique” loss in its FY12 annual report.

“What’s unique about a loss?” you may wonder. Well, it was on account of a unique
“robbery”!

Your second question – “What’s unique about a robbery?” Well, see Note 25 of the
company’s accounts…

Not just the company’s plant and machinery, and stock, the robbers also took away
the company’s building!

This led to a dramatic reduction in the company’s fixed assets and inventories and
wiped out its entire equity. Not surprisingly, even the auditors endorsed the robbery.

Anyways, as I mentioned, this is a fraud that is visible to the random eye. But most
shenanigans are not so much in the open, and must be searched for in the annual
reports and financial statements.

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Howard Schilit categorizes such shenanigans into three categories in his

book Financial Shenanigans –

1. Earnings Manipulation Shenanigans reveals how companies manipulate

the Income Statement to report higher revenue, inflated profits, or improperly
smoothed income.
2. Cash Flow Shenanigans discusses tricks used by companies to report
misleadingly high cash flow measures, including cash flow from operations
and free cash flow.
3. Key Metrics Shenanigans exposes how companies fool investors by
showcasing misleading metrics that are being billed as key measures of
business performance or economic health.

I will cover the first – Earnings Manipulation Shenanigans – in this lesson while
taking up the remaining two in the next.

I. Earnings Manipulation Shenanigans

In his brilliant 1971 hit song, John Lennon challenged us to “imagine” a perfect
world. Imagination has undoubtedly helped the world become a better place, as
people’s creativity has broken boundaries and led to countless innovations.

Imagination has inspired talented scientists, for example, to diagnose the unknown
and find cures for diseases. Similarly, technological entrepreneurs like Bill Gates and
Steve Jobs have imagined exciting ways create new products, such as Microsoft’s
Windows and Apple’s iPad, that enhance our enjoyment of life.

Occasionally, though, the imagination can run amok. Many corporate executives
have given imagination a bad name when they’ve used theirs to get too creative with
company revenue and profits.

Anyways, here are the key ways companies manipulate their earnings –

1. Recording revenue too soon and/or recording bogus revenue

2. Shifting current expenses to a later period
3. ‘Managing’ earnings using big bath accounting

Let me discuss each of these one by one.

1. Recording Revenue Too Soon and/or Recording Bogus

Revenue
Some companies will do anything under the sun to record sales before the month,
quarter, or year comes to a close. Sometimes they get creative in how they mark the
quarter’s end and push a future period’s sale into the current period.

Case 1: Take the case of Indian real estate companies. As per Indian accounting
laws, real estate developers are required to recognise revenues from ongoing projects
based on the ‘percentage of completion’ method. Under this method, revenues and
expenses of long-term contracts (which span more than one accounting period) are
recognized quarterly/yearly as a percentage of the work completed during that
quarter/year.

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Now, revenues would be recognised when the actual costs incurred to-date exceed
some percentage (25% as per Indian accounting laws) of the estimated total project
costs. Given that this practice involves a lot of estimates, the percentage of
completion method allows accelerated revenue recognition on the Income Statement.

As for real estate developers, given that revenues from ongoing projects form a
significant part of the total revenues reported by real estate developers (for example,
around 65% of the reported consolidated revenues by Unitech in FY13 were revenues
recognised on ongoing projects under the percentage of completion method, up from
26% in FY09), this methodology can be misused to inflate the reported revenues and
the resulting profit.

* PCM – Percentage of Completion Method

What is more, while some companies only include construction-linked expenses (i.e.
land conversion costs, depreciation of plant & equipment, etc) in determining the
stage of completion, others (like Unitech) include the land cost as well.

Given that land costs could form a significant part of the overall project costs
(especially in tier-1 cities), companies that include land cost in determining the stage
of completion can easily overstate their top-line by recognising revenues from
projects even before they start realising revenues from their customers which is
usually linked to construction.

Anyways, you can identify this over-statement of revenues by comparing a

company’s change in sales to change in its trade receivables.

Like see this chart for Unitech, which shows how its receivables have risen sharply
over the years, even while income has been stagnant and falling.

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This is certainly a red flag you must watch out for. Also note that Unitech’s receivable
days have increased from 64 days in FY08 to 239 days in the first half of FY14, which
again is an indicator of red flag as the company has been aggressive in booking
income even as cash from previous bookings is not coming in.

Case 2: Another example of aggressive income booking is that of Hyderabad-based

smart-card manufacturer Bartronics, whose receivables over the past few years have
been at around same levels as its annual sales – around 320+ of receivable days!

Also, when you read the company’s annual report where it shows almost zero export
revenues, and then you read its “About Us” page that mentions the following, you
know things are really shady…

Bartronics, a global consulting and IT services and Systems Integration leader in

business since 1990, focused on making businesses work, efficiently. If you have
ever struggled to justify ROI or to define and track real business outcomes,

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Bartronics can address that as we are built from the ground up to solve that for
you. Independent of the size or complexity, or handling your largest, most complex
projects, Bartronics helps you derive measurable outcomes that you have always
been looking for, from business and IT investments.

Case 3: Another Hyderabad-based company, ICSA, has followed an aggressive

revenue recognition policy as reflected in its debtor days. The change in debtor days
(from 121 in FY07 to 257 in FY12, and to 827 in FY13) raises questions about the
quality of revenues recognised in its books.

What is more, its cash profits – as reflected in Cash Flow from Operations – have
been constantly lower than its operating profits, again suggesting aggressive booking
of revenue even as cash was not coming in.

Checking for Revenue-Related Shenanigans

Some relatively easily measurable numbers through which such exaggerated
revenues can be detected are:

• Rate of change in receivables vs rate of change in revenues: The rate

of change in receivable exceeding the rate of change in revenues could be an
indication of an aggressive revenue recognition policy adopted by the
company. (see the analysis of Unitech above)

• Lower growth in operating cash flows than in operating profits: A

decline in the CFO/Operating Profit ratio or a negative CFO/Op. Profit ratio
would indicate that the reported earnings (which would be based on the
accrual system of accounting) are significantly higher than the actual cash
earnings (as measured by the cash from operations). This is an indication that
accounting aggression is at work to boost the top-line.

• Receivable days ratio: This is another way of looking at the first measure
highlighted above. A high ratio should raise concerns about the quality of
revenues recognised, because a high number likely means that the revenue

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increase might have been achieved by relaxing credit terms (see the analysis of
ICSA and Bartronics above).

2. Shifting Current Expenses to a Later Period

This is another common tactic employed by companies to showcase a better than
normal current financial performance.

Like, take the case of R&D expense. As per generally accepted accounting principles,
expenditure incurred on research should be expensed when incurred, i.e., no part of
such an expense should be recognised as an intangible asset and thus amortized over
a number of years. Expenditure incurred on development can be recognised as an
intangible asset only on fulfilment of certain conditions.

However, companies capitalize R&D costs – treat them as in intangible asset – that
helps them defer the recognition of expense on the Income Statement and instead
spread the expense over a number of years through amortization.

This inflates the company’s profits for the current year at the cost of profits in
subsequent years.

Case 1: Tata Motors is an example of a company aggressively capitalizing its R&D

expense incurred on its international brands Jaguar Land Rover (JLR). While the
proportion of total R&D expenses capitalised by its peer group (Volkswagen, BMW
and Mercedes Benz) over the past three years was at 25-35%, JLR has been
capitalising R&D expenses of 80-90%!

As per a report from Ambit Research, had JLR followed a similar policy of
capitalising ~33% of the R&D cost (in line with its peers) and recognising the
remaining 67% of R&D cost as an expense on the Income Statement, its restated
profits for the past two years is likely to have been lower by 22%.

Look for R&D expenses in a company’s financial statements, and check

for how much of that is capitalized.

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Another way through which companies defer expenses to a later period is by

amortizing or depreciating costs too slowly. This can involve depreciating assets
slower than comparable companies and increasing or stretching out the depreciation
period.

Thus, you must compare the depreciation rates charged by a company on

its various assets with that of its competitor(s). These figures are mentioned
in annual reports.

Be very careful of companies that depreciate assets too slowly. By comparing

depreciation policies with industry norms, you can determine whether a company is
writing off assets over an appropriate time span.

You should be concerned when a company depreciates its fixed assets too slowly
(thereby creating a boost to income), especially in industries that are experiencing
rapid technological advances.

Now, a more serious offense than slow depreciation is when a company changes the
depreciable life of its assets to a longer period. This often suggests that the company’s
business may be in trouble and that it feels compelled to change accounting
assumptions to camouflage the deterioration. Regardless of how management tries to
justify such changes, investors should always be wary.

3. “Managing” Earnings using Big Bath Accounting

Big bath is the practice of making a particular year’s poor income statement look
even worse by increasing expenses and selling assets. Subsequent years – especially
the very next – will then appear much better in contrast.

Using big bath, a one-time charge – or a write-off – is taken against income in order
to reduce assets, which results in lower expenses in the future.

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The write-off removes or reduces the asset from the financial books and results in
lower net income for that year. The objective is to ‘take one big bath’ in a single year
so future years, in contrast, will show increased net income.

This technique is often employed in a year when sales are down from other external
factors and the company would report a loss in any event.

For example, inventory (finished goods not sold at the end of the year) valued on the
books at Rs 100 per item is written down to Rs 50 per item resulting in a net loss of
Rs 50 per item in the current year.

Note there is no cash impact to this write-down. When that same inventory is sold in
later years for Rs 75 per item, the company reports an income of Rs 25 per item (Rs
75 minus Rs 50) in the future period. This process takes an inventory loss and turns
it into a ‘profit’.

Companies will often wait until a bad year to employ this ‘big bath’ technique to
‘clean up’ the balance sheet. Although the process is discouraged by auditors, it is still
used.

Case 1: One example of an Indian company using big bath accounting to show a
remarkable turnaround is that of Tata Motors.

At the time of launching ‘Indica’ in 2001-02, the company spent Rs 1,178 crore on the
launch process. However, the company treated this as a “development expenditure”
that was to be spread over a number of years instead of the years in which it was
incurred (2001-02).

It thus wrote-off the entire amount from its “Securities Premium Account” that is
shown in the Balance Sheet, and which helped it avoid showing the expense in its
Profit & Loss account.

Thanks to this, the company showed a net loss during 2001-02 of just Rs 53 crore as
compared to a loss of Rs 500 crore in the previous year (2000-01). If this
expenditure of Rs 1,178 crore was shown on the P&L Account, the net loss for 2001-
02 would have been more than double of that in 2000-01.

In a press release, the company accepted that “…the initiative will enable the Balance
Sheet to represent “better” operational results in the future years and the true
shareholder value.”

Case 2: Mahindra & Mahindra, which launched “Scorpio” in 2002-03, took hints
from what Tata Motors did and took a big bath on its own accounts, thereby showing
a remarkable performance in that year of Scorpio’s launch, in “contrast” to the
previous year.

As an investor, you must watch out for “big bath” charges during difficult
times. Perhaps there is no better time to record huge charges than when
the market is in a downturn.

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Since during these times investors are more focused on how companies will emerge
from the downturn, large charges are rarely frowned upon; indeed, they are often
seen as a positive (“it’s the darkest before the dawn” concept).

New CEOs sometimes use the big bath so they can blame the company’s poor
performance on the previous CEO and take credit for the next year’s improvements.

4. Other Shenanigans to Manage Earnings

Apart from the shenanigans I have explained above alongwith relevant examples
from India, here are a few more that Schilit covers in Financial Shenanigans, and
which companies use to ‘manage’ earnings to show a rosier-than-normal picture of
their performance –

a) Boosting income using one-time or unsustainable activities: Here are

some tricks employed by companies to boost their income using one-time activities –

• Turning sale of a business into a recurring revenue stream – Some

companies will sell a manufacturing plant or a business unit to another
company, and, at the same time, enter into an agreement to buy back product
from that sold business unit. These transactions are common in the
technology industry and are often used by companies as a way to quickly
“outsource” an in-house process. For example, a cellular phone manufacturer
that decides that it no longer wants to make its own batteries may sell its
battery manufacturing division to another company. At the same time, since
the phone manufacturer still needs batteries for its phones, the two companies
may enter into another agreement in which the phone manufacturer
purchases batteries from the division that it just sold. Thus, when a company
sells a business division to another company, be sure to always review both
parties’ disclosures on the sale of businesses to best grasp the true economics
of the transactions.

• Shifting normal expenses below the line – The most common way to
shift normal operating expenses below the line involves one-time write-offs of
costs that would normally appear in the operating section. For example, a
company taking a one-time charge to write off inventory or plant and
equipment would effectively shift the related expenses (i.e., cost of goods sold
or depreciation) out of the operating section into the non-operating section
and, as a result, push up operating income. Thus, watch out for companies
that constantly record “restructuring charges” in the financial statements.

• Shifting non-operating and non-recurring income above the line –

Now, apart from bundling normal operating expenses into a restructuring
charge (as I mentioned in the above point), some companies also shift non-
operating income above the line (like including a one-time income from
selling a business in operating revenue), thereby inflating their operating
income. Thus, watch for companies that include investment income as
revenue. Check their notes for “income” and “other operating income” to find
this out. While treating interest income as revenue clearly would be
appropriate for banks and other financial institutions, it certainly sounds a bit
unusual for any other business.

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b) Shifting current income to a later period: As we studied under big bath

accounting above, some companies are fine reporting smaller profits during a bad
phase so that the lower base causes the growth in the next year look much better.
Now, another way to fool investors with the ‘contrast effect’ is to shift current income
to a later period so as to show the benefit in a future instead of the present (especially
when the present is bad).

Consider a company that is growing fast and is unsure of what tomorrow holds, or
one that has benefited from a large windfall gain or a huge new contract. Investors
surely would love to see those wonderful numbers, but they also would naturally
expect management to duplicate or even ‘outperform’ them tomorrow. Meeting those
unrealistically high investor expectations may be virtually impossible, leading the
management to feel compelled to use one or a mix of following techniques to sift a
part of their current income to a future period –

• Creating reserves and releasing them into income in a later period

– As per accrual accounting, a company should record revenue only when (1)
evidence of a transaction exists, (2) delivery of the product or services has
occurred, (3) the price is fixed or determinable, and (4) payment is reasonably
assured. However, when business is booming and earnings far exceed
analysts’ and investors’ estimates, companies may be tempted not to report all
their revenue, but instead to save some of it for a rainy day. Consider a
situation in which management refuses to record some revenue that was
rightfully earned during the current period, instead storing it on the Balance
Sheet as “deferred revenue” (or unearned revenue) in the current period; then,
when the deferred revenue is needed in a later period (to boost earnings), it is
moved to actual revenue!

• Recording current-period sales in a later period – Assume that late in

a very strong period, management has achieved all the earnings targets
needed to reach its maximum bonuses for the period. Sales continue at a brisk
pace, and management has an idea that will ensure high bonus payments for
the next period as well—stop recording any more sales and shift them to the
next quarter. It is simple to do, it is unlikely that the auditors will even know
about this trick, and your customers certainly won’t object, since they will get
billed later than they expected. Nonetheless, this practice is dishonest and
misleading to investors, as it portrays higher sales in the later period. More
important, however, it shows that management makes business decisions that
are based not on sound business practices, but on dressing up its financial
reports for investors.

Warning Checklist
To conclude this lesson, here are some points you must write down in your
investment checklist – time to take out your ‘Diary of Dumb Investor’ – as part of
the red flags to check for while analyzing a company.

These points are relevant to how companies manipulate their revenue and profits. So
you must watch out for companies that are…

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• Showing receivables that are rising faster than sales, or simply receivables
rising at a fast pace
• Showing rising receivables days – this may suggest that the revenue increase
might have been achieved by relaxing credit terms
• Showing cash flow from operations (CFO) lower than operating and/or net
profit for many years in the past – warning for premature revenue recognition
• Capitalizing high proportion of R&D expenses
• Depreciating fixed assets too slowly (thereby creating a boost to income),
especially in industries that are experiencing rapid technological advances.
• Taking big bath expenses during difficult times.
• Seeing a sharp rise in profits just after a downturn. The company may have
used big bath accounting in the previous year.
• Boosting income using one-time or unsustainable activities
• Boosting income using one-time events
• Turning proceeds from the sale of a business into a recurring revenue stream
• Shifting normal operating expenses below the line
• Routinely recording restructuring charges
• Including proceeds received from selling a subsidiary as revenue
• Creating reserves and releasing them into income in a later period
• Seeing sudden and unexplained declines in deferred revenue
• Showing unexpectedly consistent earnings during a volatile time

Overall, if you want to avoid companies that may be indulging in a few or many of
these above shenanigans, be extremely wary of…

• IPOs – Most promoters and investment bankers connive to con you

• Businesses that are difficult to understand
• Businesses with a lot of regulations
• Companies making a lot of acquisitions
• Companies frequently demerging / selling its business divisions
• Real estate and construction companies
• Banks and financial institutions
• Companies with political connections
• Companies from business groups like Reliance, Sterlite, Adani
• Companies based out of Hyderabad (no offense intended; I am talking from
purely a personal experience)

In the second part on financial shenanigans (Lesson #30), I will cover ‘Cash Flow
Shenanigans’ and ‘Key Metrics Shenanigans’ that some companies use to
misrepresent their financial performance.

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Exercise
Take out your ‘Diary of Dumb Investor’ and jot down these points under “Red Flags
to Watch Out For” section of your investment checklist –

“I must check for…

• Receivables rising faster than sales, or simply receivables rising at a fast pace
• Rising receivables days – this may suggest that the revenue increase might
have been achieved by relaxing credit terms
• CFO being lower than operating and/or net profit for many years in the past –
warning for premature revenue recognition
• Capitalization of high proportion of R&D expenses
• Depreciation rates charged by a company on its various assets and compare
with that of its competitor(s) to ensure that there are no big disparities
• Company depreciating its fixed assets too slowly (thereby creating a boost to
income), especially in industries that are experiencing rapid technological
advances.
• Big bath expenses during difficult times.
• Sharp rise in profits just after a downturn. The company may have used big
bath accounting in the previous year.
• Boost in income using one-time or unsustainable activities
• Boost in income using one-time events
• Company turning proceeds from the sale of a business into a recurring
revenue stream
• Shift in normal operating expenses below the line
• Company routinely recording restructuring charges
• Company including proceeds received from selling a subsidiary as revenue
• Company creating reserves and releasing them into income in a later period
• Sudden and unexplained declines in deferred revenue
• Unexpectedly consistent earnings during a volatile time
• Signs of revenue being held back by the target just before an acquisition closes

Overall, if I want to avoid companies that may be indulging in a few or many of these
above shenanigans, I must be wary of…

• IPOs – Most promoters and investment bankers connive to con me

• Businesses that are difficult to understand
• Businesses with a lot of regulations
• Companies making a lot of acquisitions
• Companies frequently demerging / selling its business divisions
• Real estate and construction companies
• Banks and financial institutions
• Companies from business groups like Reliance, Sterlite, Adani
• Companies based out of Hyderabad (no offense intended; I am talking from
purely a personal experience)

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The Safal Niveshak Mastermind Module 3 | Lesson 29

Further Reading
• Financial Shenanigans ~ Howard M. Schilit

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