Book Summary
Financial Shenanigans, subtitled How to Detect Accounting Gimmicks and Fraud in Financial Reports, is the classic guide to reading a company’s financial statements the way a skeptic would. First published in 1993 and now in its fourth edition (2018), it was written by Howard M. Schilit, the forensic accountant known as the Sherlock Holmes of accounting, together with Jeremy Perler and Yoni Engelhart of Schilit Forensics. Its premise is simple and unsettling: companies have powerful incentives to make their results look better than they are, and the tricks they use fall into a small number of recognizable patterns.
The book organizes those patterns into seven shenanigans, grouped under three headings: earning manipulation, cash flow manipulation, and misleading metrics. Companies record revenue too soon or record bogus revenue; they boost income with one-time or unsustainable gains; they shift current expenses to a later period or shift current income to a later one to smooth results; they manipulate cash flow to look healthier than earnings suggest; and they invent metrics that flatter performance while hiding deterioration. For each pattern, Schilit and his co-authors show real cases, explain what the financial statements looked like before the trouble became public, and point to the warning signs a careful reader could have spotted.
The fourth edition updates the classic with the frauds and reporting offenders of the past quarter century, from Enron, whose story is told in full in The Smartest Guys in the Room, to more recent cases in global markets, and it adds material on how companies use acquisitions to hide deteriorating businesses. The result is a book that reads less like a textbook and more like a detective’s casebook, which is exactly why investors keep recommending it: it teaches a skill, spotting trouble before it becomes a loss, that no stock screen can replace.
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Who are Howard M. Schilit, Jeremy Perler, and Yoni Engelhart?
Howard M. Schilit, Ph.D., CPA, is the founder and chief executive of Schilit Forensics, an investment research consultancy, and previously founded the Center for Financial Research and Analysis (CFRA), which served more than 500 investment firms. A former professor at American University, he has testified before Congress and the Securities and Exchange Commission on accounting practices, and his work has been featured in The Wall Street Journal, Fortune, and The New York Times. Jeremy Perler, CFA, CPA, is a partner at Schilit Forensics who previously held positions at Coatue Management, CFRA, and PwC, and has served on advisory committees for the Financial Accounting Standards Board and the Public Company Accounting Oversight Board. Yoni Engelhart, CFA, is a partner at Schilit Forensics who previously held positions at Partners Capital, Wellington Management, and CFRA.
The authors’ day job is the book’s credibility. They are not academics describing fraud in theory; they are practitioners hired by hedge funds and mutual funds to find bad actors before they blow up, and Financial Shenanigans is essentially their training manual, published. That is why the book’s examples are specific and its warning signs are practical rather than theoretical.
Lessons From Financial Shenanigans
Revenue is the easiest number to fake, so check it first. The first shenanigans in Financial Shenanigans all involve revenue: recording it too soon, recording revenue that should never have been recorded, or inflating it with related-party deals. An investor who learns to compare revenue growth with cash collected from customers, and to ask why receivables are growing faster than sales, will catch more frauds than any other single habit the book teaches.
Cash flow is harder to fake than earnings, but not impossible. One of the book’s most useful updates is its treatment of cash flow manipulation: companies that cannot fake earnings anymore have learned to fake cash flow instead, by stretching payables, securitizing receivables, or reclassifying items. The lesson is not to trust any single number, but to check earnings, cash flow, and the balance sheet against each other and to investigate when they disagree.
Watch for cultures that incentivize dishonesty. Schilit and his co-authors argue that accounting tricks rarely appear in isolation; they appear in companies whose cultures reward hitting targets at any cost, whose executives are paid mostly in stock, or whose boards ask too few questions. A skeptical investor should treat aggressive targets and unusually smooth earnings as warning signs in themselves, not as evidence of good management.
Acquisitions can hide deterioration. The fourth edition’s material on acquisitions is its most timely contribution: a struggling company can buy growth, bury problems in purchase accounting, and report impressive headline numbers while its underlying business decays. Investors should always ask what a company’s organic growth looks like without its acquisitions, and what the acquired business actually earns.
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Criticisms of the Book
This is a dense, technical book, and readers without some comfort reading financial statements will find parts of it heavy going. Schilit and his co-authors explain their terms, but the book assumes a reader willing to work through accounting concepts, and it is best read slowly with a company’s actual financial statements nearby for practice. Casual readers looking for a narrative about fraud will find The Smartest Guys in the Room more entertaining, and should read that first.
The book’s case studies also carry a hindsight risk. It is easier to spot warning signs after a fraud is exposed than before, and the book’s confident tone can make detection sound simpler than it is in real time, when the same warning signs appear in honest companies too. Readers should treat the book as a way to raise better questions, not as a foolproof fraud detector, and should remember that even Schilit’s own clients sometimes get surprised.
Who is This Book For?
This book is for investors who read financial statements and want to protect themselves from accounting fraud, for analysts and accountants who want the standard reference on the subject, and for business students studying financial reporting. It is the natural companion to narrative fraud books like The Smartest Guys in the Room: that book tells you what happened at Enron, and this one teaches you how to spot the next one.
It is less useful for beginners in investing, who should start with a general investing book and return to this one when they are ready to analyze individual companies, and for readers who only invest in index funds, for whom company-level accounting analysis matters less. The book’s value is proportional to how much individual stock analysis you actually do.
Final Thoughts
Financial Shenanigans is the rare investing book that can save a reader more money than it costs by a wide margin, if it prevents even one bad investment. Schilit, Perler, and Engelhart give investors the patterns, the warning signs, and the skepticism to read financial statements like a detective rather than a fan. It is demanding, occasionally technical, and entirely worth the effort for anyone who picks individual stocks.
