How to Read a Financial Report, 9th Edition

18 FINANCIAL ENGINEERING

What Financial Engineering Is Not

Before we dive into the concept of financial engineering and what it entails, it’s helpful to identify what financial engineering is not. We want to put out of your mind any preconceived notions about the topics of fraudulent financial reporting or heavy-handed manipulation of accounting and other deliberately misleading information put into financial reports.

There are two specific points that are important to understand:

1. Financial engineering does not refer to the intentional misreporting and misleading presentation of accounting transactions and financial operating results. It does not refer to cooking the books. While we would love to recall some of the great accounting frauds of the past (e.g., Enron), this subject would warrant a whole book to itself. We just point out here that almost all “great” accounting frauds were supported by executive-level management collusion. Multiple members of the executive management team worked in complicity to report financial information with the willful intent to deceive and mislead. We offer here only a couple of advisory points to remember when it comes to fraudulent financial information. Be on the lookout for any signs of executive-level collusion, such as boards of directors that aren’t truly independent. Be careful if the CPA auditor of the financial report is relatively unknown. Finally, be extra careful of tightly controlled insider-operated businesses, which are more ...