Satyam Surpasses Enron

It’s the biggest corporate fraud in Indian history, and the press labeled it “India’s Enron” as soon as the news broke. But Satyam looks to be worse than Enron in scope, if not in scale. How can we say that before the authorities have completed their investigation? We can tell by the absence of early warning signs.

Satyam Computer Services is one of India’s leading information technology companies and ranks 185 of the Fortune 500 companies among its clients. Early last December, the company’s Chairman, Ramalinga Raju, confessed to using fake revenues to inflate profits over a number of years. That led to a build up of what Raju called “artificial cash” of over $1.0 billion (Rs 50 billion) by the end of September 2008.

Through long, bitter experience, investors have developed a set of early warning signs of financial reporting fraud. One of the strongest is the difference between income and cash flow. Because overstated revenues cannot be collected and understated expenses still must be paid, companies that misreport income often show a much stronger trend in earnings than they do in cash flow from operations.

But you can see there is no real difference in the trends in Satyam’s net income and its cash flow from operations over the last five years. That’s not because the earnings were genuine; it’s because the cash flows were manipulated too. To do that, Raju had to forge accounts receivable and falsify collections.

The fake cash flows led to the bogus bank balances. To keep from tripping the income-cash flow alarms, Raju had to manipulate nearly every account related to operations. It was a stunningly comprehensive fraud, likely to be far more extensive than what Skilling, Lay, and Fastow did at Enron.