Guide
You're an investor. You have cash to put to work in three manufacturing companies, and a bank that will lend you more. Each company wants your money, and each one reports its results every quarter. All three may be honest when the game starts. Any of them may start faking sales later, usually when it's under pressure. The game teaches you to tell reported profit from real performance: to judge earnings quality, and to catch fraud before the market does.
Starting a game
Every game gives you $100,000 in cash and 12 quarters to play. You start with no shares. The companies' last 4 quarters are already on screen, so you can see how each one normally behaves before you invest. The three companies differ: one promises steady growth, one promises fast growth, and one carries a lot of bank debt. None of that tells you who will be honest.
Random seed decides everything else: demand, each company's fortunes, and every roll of the dice. Leave it blank for a fresh game, or enter a number to play the same game again. After a game ends, Replay Seed starts the identical game, so you can try a different strategy against the same companies.
Reading a company card
Each company gets a card, side by side, so you can compare the three line by line. The blue line shows what the company actually did. The figures below it show what the company says it did. Most of the time they agree. Your job is to notice when they don't.
1. What it did (blue). Goods move left to right, from suppliers to customers:
- Raw
- Materials bought from suppliers, waiting to be used.
- Making
- Units being made.
- Ready
- Finished units waiting for a customer.
- Shipped
- Units delivered to customers this quarter, and the change from last quarter.
Only shipped units earn real revenue. A company can build up raw materials or finished goods, but it gets paid only for what leaves the building. The company can't change these numbers with accounting.
2. What it claims. The company's reported results for the quarter: revenue, net income, operating cash flow, receivables (money customers owe it) and days to collect. These come from the company's own accounts. Management chooses how to report them. Revenue/unit is reported revenue divided by units shipped. It should hold roughly level when the revenue is real.
3. The charts. Each compares a claim (gold) with a fact (blue) over every quarter so far:
- Net income vs. operating cash flow, in the Statements tab. Profit the company reports against cash that actually came in. For a healthy company the two lines move together, with cash usually a little above profit: depreciation is a cost that uses no cash that quarter. What matters is the gap closing or reversing. When profit catches up with cash and pulls ahead of it, the profit hasn't been collected yet. It may never be.
- Revenue vs. units shipped, on each card. Both lines start at 100 so you can compare their shapes. If revenue keeps rising while shipments stay flat, ask where the extra revenue is coming from.
4. The Sloan Ratio. One number that sums up the first chart: the gap between reported profit and cash over the last four quarters, as a share of the company's assets. Tap the i to see the calculation. Grey is normal, amber is elevated (above 5%), and rose is high (above 10%).
A high Sloan Ratio is a question, not an answer. Honest companies can have one too. A company growing fast often gives customers longer to pay and builds stock ahead of demand, so its profit runs ahead of its cash for a while. Check the physical side. If shipments are rising with revenue, the growth is probably real. If revenue is rising and shipments aren't, be suspicious.
5. Trading. Enter a dollar amount and choose Buy or Sell (Sell all gets you out completely), or Short and Cover. The line underneath shows your position at today's price.
The tabs above the cards: Statements puts the three companies side by side for any quarter, with the net income against cash flow charts; Ratios shows each company's Sloan Ratio over time; Share prices charts all three; and News keeps every quarter's news. Your net worth and your return against buy-and-hold are at the right of the tabs. The bar at the bottom holds the bank and End quarter.
The news wire
After each End quarter, the news wire pops up with what the public would see: earnings results, companies hitting or missing their targets, changes in industry shipments, and frauds when they're discovered. It never tells you who is reporting false figures. A company that hits its target every quarter may be doing well, or may be making the numbers up. You have to work that out from the cards. The News tab keeps every quarter's news.
Buying and selling
You can own shares in any or all three companies at once, and change your mind every quarter. Enter a dollar amount on a company's card and choose Buy or Sell. The game trades whole shares: a buy spends no more than the amount you entered, fee included, and a sell raises about that amount. Sell all sells every share you hold. All three companies start at $20.00 a share, so a higher price later means a higher return. You trade at the current share price, and your trades don't move it. Companies don't pay dividends, so your return comes only from share prices. Each trade costs a fee of 0.4% of its value, so buying and selling back costs 0.8%.
Short-selling
If you think a company's shares will fall, sell them short: you sell shares you've borrowed, and the sale price goes into your cash. You owe the shares back, so choose Cover to buy them back at the price then. If the price has fallen, you keep the difference; if it has risen, you pay it. Your shorts can reach half your net worth, checked when you short, and cost 1% of their value a quarter until you cover, so a wrong hunch costs you even if the price stands still. You can't hold and short the same company: sell before shorting, and cover before buying.
Margin call. If, after a quarter, your shorts are worth more than your whole net worth, your broker buys them all back at that quarter's prices, fee included. A short on a company whose price keeps climbing can cost a lot, but it can't take everything.
If the SEC charges a company you've shorted, its shares are worth nothing, and your short closes at $0: you keep the whole sale price. Shorting the company that's lying, before the charge, is the best catch there is. Shorting an honest one is a false alarm.
The Bank
You can borrow to invest more, and repay whenever you like. Interest is charged every quarter on what you owe: 2% a quarter. You can borrow until your debt reaches half your net worth. If share prices fall and your debt ends up above that, you don't have to sell anything, but you can't borrow more until it's back under. Borrowing magnifies both outcomes. If you borrow to buy a company that collapses, you lose the shares and still owe the bank. There's no bankruptcy: even if you end up owing more than you own, you play to the end.
How share prices move
The market prices each company on the profits it reports, not on its true performance:
- Price = a multiple × the last four quarters' reported earnings per share.
- The multiple rises with reported growth, from 6 for a shrinking company to 25 at most. A company reporting 1% growth a quarter trades at about 11; one reporting 5% trades at about 15.
- Missing a target costs an extra cut of 3 times the shortfall, up to 15% that quarter, on top of the lower earnings and lower multiple: missing by 1% costs 3%, and by 5% or more the full 15%. The target is last quarter's reported earnings grown at the company's promised rate, shown on each row as "next target".
That last rule is why fraud happens here. When a company is about to miss, management can take the hit or make the numbers up. And because the market believes reported profits, a company that's reporting false figures can see its share price keep rising, right up until it's caught.
When a fraud is discovered
A lie always runs at least 2 quarters before anyone outside can catch it, so a careful reader has time to act. From then on, auditors, short sellers and whistleblowers can uncover it in any quarter. The bigger the fraud grows and the longer it runs, the more likely it is to come out, and every fraud comes out before the game ends: if nobody has caught it a few quarters after it began, the SEC charges the company. The news reads "The SEC charges …", trading stops, the share price drops to zero at once, and every share you still hold is worthless, while a short you hold in it closes at $0. You can't sell on the news: selling one quarter too late costs the whole position.
Ending the quarter
When you've made your trades, choose End quarter. The companies make and ship goods, report their results, and share prices update. The news wire pops up with what happened.
Game over and your score
After quarter 12 the game shows your debrief, with two scores:
- Net worth vs. buy-and-hold: your shares, plus cash, minus what you owe the bank and the shares you owe on shorts. It's compared with what you'd have if you'd split your starting cash equally across the three companies and never traded, on the same seed. Beating that means your decisions added value.
- Detection score: the game reveals which companies were honest and which lied, and scores each company. You "hold" a company when your shares in it are worth at least 5% of everything you own (shares plus cash), checked each time you end a quarter. A handful of shares doesn't count. A short counts the same way, by the value of the shares you owe.
| What was true | What you did | Points |
|---|---|---|
| Honest | Held it at the end | +1 |
| Honest | Held it, then sold out | −1 |
| Honest | Never held it | 0 |
| Honest | Shorted it | −1 |
| Fraud | Short when the SEC charged it | +4 |
| Fraud | Sold out after the false figures began, before the SEC charged it | +2 to +4 (more the earlier you sold) |
| Fraud | Shorted it, then covered before the SEC charged it | +2 |
| Fraud | Never held it after the false figures began | +2 |
| Fraud | Still held it when the SEC charged it | −4 |
Missing a fraud costs four times as much as a false alarm, because it does in real life: selling an honest company early costs you some upside; holding a fraud costs you everything.
Profit is an opinion, cash is a fact: the Sloan Ratio, in this game
In 1996 the accounting professor Richard Sloan showed that companies whose profits run well ahead of their cash flow tend to disappoint later, and that the market is slow to notice. The gap between the two is called accruals: profit that has been booked but not collected. Some accruals are normal. Customers pay late, and stock gets built ahead of sales. But accruals are also where manipulation hides, because booking revenue is a judgment, while cash in the bank isn't.
In this game, a dishonest company books sales it never made. The fake sales show up as money customers supposedly owe, which is never collected. Reported profit rises, cash doesn't, and the Sloan Ratio climbs.
What the ratio can't tell you is why profit and cash have split. A fast-growing honest company can look just the same. That's what the blue line on each card is for: real growth ships real goods.
Level 2 adds a matching section for the Beneish M-Score, which combines the Sloan Ratio's signal with seven other warning signs.