Can You Spot Fudged Financials?

It’s been more than a decade since the financial scandals perpetrated by Enron, World Com, and a host of others hit the evening news. Yet the images of top executives being forced to do the perp walk are still fresh in the collective mind. So are the memories of millions lost in retirement savings.

Investors, regulators, lawmakers, and the public at large were aghast and asking the same questions:  How had these corporations managed to dupe, not only the many unwary investors, but also the regulators? How had they fudged their financial statements and gotten away with it?

And the most important questions asked by those that lost their investments were: How the heck is the average Joe supposed to make sense of those complex financial statements? How could we have seen it coming?

We decided to answer all those questions by writing our book, The Truth Behind the Numbers in Financial Statements.  It’s a step-by-step guide to understanding exactly what a company’s financial statements are telling you, and more importantly, what they might not be telling you.

Today, the attempts at creative number fudging are on the rise again.  The sluggish economy and erratic market seems to have tempted some companies to try and rise above the fray by presenting themselves as profitable, unique new opportunities.

This is particularly true in the case of some social media IPOs such as Groupon. Fortunately someone at the SEC was paying attention when they read Groupon CEO and founder Andrew Mason’s cover letter accompanying the Registration Statement.  In an apparent attempt to dazzle those staid old SEC agents, Mason pointed out just how unique and unusual the Groupon opportunity would be when he wrote, “We don’t measure ourselves in conventional ways.”  Wait, … what?

Naturally the results were that Groupon was forced to redo their numbers in accordance with stricter accounting standards and to demonstrate that they do indeed measure themselves in more “conventional ways.”  Under review are Groupon’s “self selected” financial metrics, including gross profits and consolidated segment operating income (CSOI). Amendments are still being made, thus the long awaited IPO will be delayed until toward the end of September.

The SEC is taking a hard look at tech/social media IPOs because they are a relatively new market sector, and they want to set some strict accounting standards early on.  But what about companies that have been offering stocks for years, like Enron had been? Are they still in compliance with strict accounting standards? How many of those stocks do you own?  How many might you be tempted to buy in the future?

Fortunately the headline-grabbing sensational financial statement fraud—like that committed by Enron—is relatively rare.  In fact, according to The Association of Certified Fraud Examiners, that level of malfeasance only accounts for about 4.8% of all fraud cases, though they do create the most damage.

It’s worth noting that it can sometimes take up to 18 to 24 months before number fudging comes to light and things begin to unravel.  That means that any financial mischief that took place back in 2009, might not become evident until later this year, or even next year.

Are you going to just wait around to see what happens? Things in the financial markets are already so unpredictable and unstable, the quicker you take a close look at your portfolio and the companies behind those holdings, the better.

If you’re not already well versed in understanding how to read financial statements, we recommend that you pick up a copy of The Truth Behind the Numbers in Financial Statements. All the basics are there for you arranged in an easy to read, easy to understand format beginning with how to spot the early warning signs of trouble in a company, and how to perform your own due diligence.

Even though it will be a minor investment of your time and money, it could go a long way to protect your major investments.